ANNUAL
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For
the Fiscal Year Ended December 31, 2016

Commission
File No. 333-150332

DRONE
AVIATION HOLDING CORP.

(Exact
name of registrant as specified in its charter)

Nevada

46-5538504

(State
or other jurisdiction of

incorporation
or organization)

(I.R.S.
Employer

Identification
No.)

11651
Central Parkway #118

Jacksonville
FL

32224

(Address
of principal executive office)

(Zip
Code)

(904)
834-4400

(Registrant’s
telephone number, including area code)

Securities
registered pursuant to Section 12(b) of the Act: None

Securities
registered pursuant to Section 12(g) of the Act: None

Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined by Rule 405 of the Securities Act. Yes ☐
No ☒

Indicate
by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. Yes ☒
No ☐

Indicate
by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange
Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90 days. Yes ☐ No ☒

Note:
The registrant is a voluntary filer, but has filed all reports it would have been required to file by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months if it was subject to the filing requirements thereof.

Indicate
by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive
Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 229.405 of this chapter) during the
preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒
No ☐

Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not
contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☒

Indicate
by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act.

Large
accelerated filer ☐

Accelerated
filer ☐

Non-accelerated
filer ☐

Smaller
reporting company ☒

(Do
not check if a smaller reporting company)

Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐
No ☒

The
aggregate market value of the voting common equity held by non-affiliates of the registrant was $10,766,464 based on the average
bid price and asked price per share of the Common Stock as quoted on the OTCQX on the last business day of the registrant’s
most recently completed second fiscal quarter (June 30, 2016).

As
of March 17, 2017, there were 8,682,220 shares of registrant’s common stock outstanding.

This
Annual Report on Form 10-K (this “Annual Report”) contains “forward-looking statements” that represent
our beliefs, projections and predictions about future events. All statements other than statements of historical fact are “forward-looking
statements,” including any projections of earnings, revenue or other financial items, any statements of the plans, strategies
and objectives of management for future operations, any statements concerning proposed new projects or other developments, any
statements regarding future economic conditions or performance, any statements of management’s beliefs, goals, strategies,
intentions and objectives, and any statements of assumptions underlying any of the foregoing. Words such as “may,”
“will,” “should,” “could,” “would,” “predicts,” “potential,”
“continue,” “expects,” “anticipates,” “future,” “intends,” “plans,”
“believes,” “estimates,” and similar expressions, as well as statements in the future tense, identify
forward-looking statements.

These
statements are necessarily subjective and involve known and unknown risks, uncertainties and other important factors that could
cause our actual results, performance or achievements, or industry results, to differ materially from any future results, performance
or achievements described in or implied by such statements. Actual results may differ materially from expected results described
in our forward-looking statements, including with respect to correct measurement and identification of factors affecting our business
or the extent of their likely impact, the accuracy and completeness of the publicly available information with respect to the
factors upon which our business strategy is based, or the success of our business. Furthermore, industry forecasts are likely
to be inaccurate, especially over long periods of time. Factors that may cause actual results, our performance or achievements,
or industry results to differ materially from those contemplated by such forward-looking statements include, without limitation,
those discussed in “Item 1A. Risk Factors” of this Annual Report.

Forward-looking
statements should not be read as a guarantee of future performance or results and will not necessarily be accurate indications
of whether, or the times by which, our performance or results may be achieved. Forward-looking statements are based on information
available at the time those statements are made and management’s belief as of that time with respect to future events, and
are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed
in or suggested by the forward-looking statements. Important factors that could cause such differences include, but are not limited
to, those factors discussed in “Item 1A. Risk Factors” of this Annual Report and elsewhere in this Annual Report.

PART
I

Item
1. Business

Organization

Drone
Aviation Holding Corp. has two wholly-owned subsidiaries: Lighter Than Air Systems Corp. (“LTAS”) and Drone AFS Corp.
(“AFS”). Drone Aviation Holding Corp. was incorporated in Nevada on April 17, 2014, as a wholly-owned subsidiary of
MacroSolve, Inc., an Oklahoma corporation (“MacroSolve”), and effective April 30, 2014, to consolidate our operations
into an entity incorporated in Nevada, MacroSolve merged with and into us. On June 3, 2014, we acquired Drone Aviation Corp. through
a share exchange transaction, and on March 26, 2015, Drone Aviation Corp. merged with and into us. As a result of the share exchange
and merger with Drone Aviation Corp., we acquired Drone Aviation Corp.’s subsidiary, LTAS. AFS became our subsidiary upon
its formation on July 9, 2015. Unless the context otherwise requires, the terms “we,” “our,” “us,”
“Company,” “Drone Aviation” and “DAC” as used in this Annual Report refer to Drone Aviation
Holding Corp. and its subsidiaries.

We
design, develop, market and sell lighter-than-air (“LTA”) advanced aerostats, tethered drones, and land-based intelligence,
surveillance and reconnaissance (“ISR”) solutions. We focus on the development of a tethered aerostat known as the
Winch Aerostat Small Platform (“WASP”), as well as tethered drone products, including the WATT and BOLT electric tethered
drones launched on March 2, 2015 and July 13, 2016, respectively. The WATT and BOLT products are designed for commercial and military
applications and provide secure and reliable aerial monitoring for extended durations while being tethered to the ground via a
high strength armored tether.

Products

We develop a lighter-than-air
advanced tethered aerostat known as the WASP and tethered drone products, including the WATT and the BOLT tethered drones. The
WASP tethered aerostat system is a lighter-than-air, compact aerostat platform that is either self-contained on a trailer that
can be towed by a military all-terrain vehicle, or “MATV,” or mine resistant ambush protected vehicle, or “MRAP,”
or other standard vehicle, or operated from the bed of a pickup truck. It is designed to provide semi-persistent, mobile, real-time
day/night high definition footage for ISR, detection of improvised explosive devices, border security and other governmental and
civilian uses. All of our products can also be utilized for disaster response missions by supporting two-way and cellular communications
and acting as a repeater or provider of wireless networking.

The
aerostat systems have a tethered envelope filled with helium gas, either a stabilized ISR payload or communications payload, portable
ground control station and a datalink between the ground station and the envelope. Hovering at up to 2,000 feet above the ground,
the systems provide surveillance and communications capabilities with relatively low acquisition and maintenance costs. The
systems require an operational crew of a minimum of two personnel, relatively simple maintenance procedures, and a quick retrieval
and helium top-off for re-inflation.

The
WASP is a mobile, tactical-sized aerostat capable of carrying a variety of payloads in support of military operations helping
troops in the field have a tactical edge while communicating over greater distances. The WASP leverages aerostat technology to
elevate network payloads to an advantaged height to enable persistent network connectivity while reducing risk to units conducting
missions. U.S. Army-owned WASP tactical aerostats have undergone and successfully completed a number of field tests and exercises,
including the U.S. Department of Defense (“DoD”) Enterprise Challenge, Stormforce Exercise, and various Army Network
Integration Evaluations, which allows the U.S. Government to evaluate, among other things, the WASP’s ability to provide
secure communications and capture and relay real-time, high definition video to various handheld devices, tablet computers and
other deployed systems. In March 2016, we were awarded a contract from a U.S. Government customer for our WASP tactical aerostats,
which were delivered in August 2016. As a result of our ongoing relationship with our U.S. Government customers, we will continue
to support the U.S. Army-owned WASP systems for future operations and exercises.

1

WATT
was our first model of a new line of commercial-grade electric tethered drones designed to provide secure and reliable aerial
monitoring for extended durations while being connected to a ground-based, software-controlled winch via a safe and secure armored
tether line. In September 2016, we were awarded a contract from a U.S. Government customer for our WATT tethered drones, which
were delivered in December 2016. The concept of the tethered drone system is built on the strength of our experience in developing
tethered solutions for our aerostat products and combining that with the advantages of multi-rotor copters. The result is a robust
capability designed to be used in almost all weather environments and controlled with the push of a button. The WATT is designed
to take off, hover and land via remote control while connected by a unique tether technology where all data, controls and endurance
are built into the tether. The same components and systems that our military customers rely on in our launcher systems are being
incorporated into the self-contained copter system in order to produce a heavier-than-air, tethered product. The WATT is a complete
turnkey system that can be launched within minutes of unpacking from a standard case stored in a host vehicle. Once launched,
WATT is designed to hover in a stationary position directly above its launch site at one of several preset altitudes of up to
300 feet for up to 8 hours while a highly-stabilized military-grade/broadcast quality HD video image can provide a 360° live
aerial monitoring feed directly through the tether to its host vehicle or to a network of mobile devices, such as tablets or laptop
computers. Compact and lightweight, the WATT system features the ability to draw power from both its host vehicle or independently
provide up to 8 hours of operation through its own ground power equipment that is specially designed to be transported and deployed
from commercial vehicles, such as TV production trucks, first responder vehicles and common agriculture/infrastructure equipment
using its standard 120 volt adapter.

On
July 13, 2016, we announced the official launch of the BOLT platform, the newest addition to our tethered drone portfolio. Designed
to meet a wide range of military applications requiring persistent, heavy lift capabilities, the BOLT coaxial tethered helicopter
delivers rapid setup, high mobility and whisper-quiet operations at altitudes of up to 800 feet. BOLT has a field changeable universal
payload bay which supports radio, signals intelligence, or “SIGINT,” and ISR packages of up to 15 pounds and requiring
up to 1 kilowatt of power. BOLT was unveiled at ADS, Inc.’s Warrior Expo East industry conference event on July 14, 2016.
The Company has received initial interest from a select number of potential customers since the introduction and plans to custom
manufacture each vehicle based on order specifications it receives in the future.

Market

The
market for our LTA advanced aerostats and tethered drones has grown significantly over the last several years and has seen interest
increase significantly following the adoption of new commercial drone regulations (Part 107) adopted by the U.S. Federal Aviation
Administration (“FAA”) at the end of August 2016 because our tethered drone product line is designed to comply with
the FAA’s regulations. The military has transformed into a smaller, more agile fighting force in need of a network of technologies
to provide improved observation, communication and precision targeting of combat troop locations, which are often embedded in
dense population centers or dispersed in remote locations. Our products provide critical observation and communication
capabilities serving the increased demand for ISR and communications, including real-time tactical reconnaissance, tracking, combat
assessment and geographic data, while reducing the risks to our troops in theatre. Finally, in a highly constrained fiscal
environment, we believe the typically lower acquisition and use/maintenance costs of LTA advanced aerostats and tethered drones
make them more appealing compared to their heavier than air manned or larger LTA unmanned system alternatives.

The
markets for our systems on a stand-alone basis and/or combined with other payloads relates to the following applications, among
others:

Governmental
Markets:

●

International,
federal, state and local governments and agencies thereof, including DoD, U.S. Drug Enforcement Agency, U.S. Homeland Security,
U.S. Customs and Border Protection, U.S. Environmental Protection Agency, U.S. Department of State, U.S. Federal Emergency
Management Agency, U.S. and state Departments of Transportation, penitentiaries, and police forces;

2

●

Military,
including the U.S. Army Space and Missile Defense Command and U.S. Air Force installations;

●

ISR,
including the United States Special Operations Forces;

●

Border
security monitoring, including U.S. Homeland Security, to deter and detect illegal entry;

●

Drug
enforcement along U.S. borders;

●

Monitoring
environmental pollution and sampling air emissions; and

●

Vehicle
traffic monitoring, including aerial speed enforcement by state and local law enforcement agencies.

We
sell our products directly to end customers and through distribution agreements with firms such as ADS Inc., a leading value-added
logistics and supply chain solutions provider that serves the U.S. military, federal, state and local government organizations,
law enforcement agencies, first responders, partner nations and the defense industry. In addition, our products are included in
the U.S. Government’s GSA Schedule, which allows government customers to directly negotiate and acquire products and services
from commercially-listed suppliers.

Our
proprietary and recently patented tethering technology, in particular, our tension control winch system, is an important competitive
differentiator in the market. The winch systems utilized in our products have undergone extensive testing and continued refinement
through coordination with customers, including the U.S. Army.

3

We
believe the current market competitors to the WASP aerostat system include a large number of companies ranging from small “mom
and pop” tethered aerostat and balloon companies to large defense contractors, including TCOM, Raytheon, Lockheed Martin,
ISL, ILC Dover, Compass Systems, Raven Aerostar and American Blimp Corporation. We believe there are numerous commercial
drone companies, such as DJI and Parrot, offering free flying drones for pleasure and commercial use, as well as many larger drone
manufactures, such as Northrop Grumman, AeroVironment, Inc. and Boeing,
offering military grade free flying drones to the U.S. Government, which could compete with the WASP. There are very few commercial
grade tethered drone competitors for our WATT and BOLT tethered drone systems that remain tethered to the ground via a high strength
armored tether, including Cyphy Works Inc. located in Danvers, MA, Elistair located in Lyon, France, Hoverfly Technologies, Inc.
located in Orlando, Florida and Skysapience located in Yokneam, Israel.

Many
of our LTA aerostat competitors have received considerable funding from government or government-related sources to develop and
build LTA aerostats. Most of these organizations and many of our other competitors have greater financial, technical,
manufacturing, marketing and sales resources and capabilities than we do. We anticipate increasing competition as a result of
defense industry consolidation, which has enabled companies to enhance their competitive position and ability to compete against
us. In addition, other companies may introduce competing aerostats or solutions based on alternative technologies that
may adversely affect our competitive position. As a result, our products may become less or non-competitive or obsolete.
For further discussion of certain risks relating to competition, see “Item 1A. Risk Factors” of this Annual Report.

Technology,
Research and Development

We
conduct the development, commercialization and construction of the WATT and BOLT tethered drones and WASP aerostat systems in-house.

Our
research and development efforts are largely focused on the tethered drone systems and LTA aerostat systems. We have developed
a “non-military spec” aerostat system for use in more commercial or governmental applications that does not require
the level of durability and ruggedness of the current militarized model, and we continue to work on different models with different
payloads for various applications.

The
concept of the WATT and BOLT systems are built on the strength of our years of developing tethered solutions for our LTA aerostat
products combined with the advantages of rotor copters. The result is a robust product designed to be utilized in almost all weather
environments and controlled with the push of a button. Our tethered drones are designed to take off, hover and land via remote
control all while being connected by a unique tether technology where all data, controls and endurance are built into the tether.
The same components and systems that our military customers rely on from our launcher systems are incorporated into our self-contained
tethered drone systems in order to produce a unique heavier than air, tethered product offering.

For
the year ended December 31, 2016, we spent $1,218,614 and for the year ended December 31, 2015, we spent $744,452 on research
and development activities. Research and development expenditures are not borne directly by customers nor are the costs accounted
for in our pricing models.

Strategic
Partners

We
are party to several agreements with strategic partners and distributors to assist us with the marketing and sales of various
products, as we currently have limited in-house sales capabilities. Current relationships include:

●

A
sales and distribution partnership with U.S. government prime contractor ADS Inc.;

●

A
solution development arrangement with Infor for the integration of the WATT tethered drone and Infor’s Enterprise Asset
Management system;

●

A
Master Partner Agreement with Adobe Systems Incorporated to collect video streams for analytics; and

●

A
three-year marketing and integration partnership commenced in March 2015 with L3 Communications Corporation for a “L3-Branded”
WASP targeting prime contract customers.

4

Intellectual
Property

On
September 18 and 19, 2014, we filed provisional patent application numbers “62/052,289” and “62/052,946”
entitled “Tethered Portable Aerial Media broadcast System” based on the tethered drone system. On September 18, 2015,
we filed a utility patent application claiming a priority date of the two provisional patent applications and having application
Serial Number “14858467” entitled “Apparatus and Methods for Tethered Aerial Platform and System.”
On July 7, 2015, we filed a provisional patent application number “62/189,341” entitled “Apparatus, Methods
and System for Tethered Aerial Platform.” On September 20, 2016, the United States Patent and Trademark Office (“USPTO”)
issued patent number 9,446,858 entitled “Apparatus and methods for tethered aerial platform and system.” This new
patent on our electric tethered aerial platform (“ETAP”) technologies covers the core systems currently incorporated
into the WATT and BOLT products. On December 5, 2016, we filed provisional patent application number “62/430,195”
entitled “System for Converting an Onboard Battery Powered Drone to a Ground Powered Tethered Drone.”

In
addition, the Company’s intellectual property portfolio includes an exclusive commercial license to vision-based navigation
and advanced autonomous flight management software that it acquired in 2015 and exclusive commercial licenses to a number of unmanned
vehicle technologies developed by Georgia Tech Research Corporation, including “GUST” (Georgia Tech UAV Simulation
Tool) autopilot system.

Our
success and ability to compete depends in part on our ability to develop and maintain our intellectual property and proprietary
technology and to operate without infringing on the proprietary rights of others. As we continue the development of the tethered
drone and aerostat systems, we expect that we will rely on patents, trade secrets, copyrights, trademarks, non-disclosure agreements
and other contractual provisions. We have also registered the trademark “Blimp in a Box.” In certain cases,
when appropriate, we opt to protect our intellectual property through trade secrets as opposed to filing for patent protection
in order to preserve confidentiality. All of our employees are subject to non-disclosure agreements and other contractual
provisions to establish and maintain our proprietary rights. For further discussion of risks relating to intellectual property,
see “Item 1A. Risk Factors” of this Annual Report. For further discussion about the intellectual property rights and
licenses and minimum royalties, see Note 12 – Commitments and Contingencies in the Notes.

Dependence
on a Few Customers and Regulatory Matters

We
believe there is a large, growing market for our commercial tethered drones internationally as well as in the U.S. With the recently
enacted guidelines for commercial drone use in the U.S. by the FAA (Part 107), we have witnessed a growing U.S. market for commercial
drone applications that our tethered drones can serve. Until the FAA officially adopted and published these guidelines in late
August 2016, we and our customers were restricted to operating our tethered drones in the National Air Space under either FAA
granted exemptions or Certificates of Authorization. In addition to domestic opportunities, we are evaluating various international
markets where the FAA does not control the airspace and where our tethered drones can potentially be operated. We anticipate that
the majority of our LTA aerostat revenue at least in the foreseeable future will come from U.S. Government and Government-related
entities, including the DoD and other departments and agencies. Government programs that we may seek to participate
in compete with other programs for consideration during Congress’s budget and appropriations hearings, and may be affected
by changes not only in political power and appointments, but also general economic conditions and other factors beyond our control. Reductions,
extensions or terminations in a program that we are seeking to participate in or overall defense spending could adversely affect
our ability to generate revenues and realize any profits. We cannot predict whether potential changes in security,
defense and intelligence priorities will afford opportunities for our business in terms of research and development or product
contracts, but any reduction in government spending on such programs could negatively impact our ability to generate revenues.

5

We
have registered as a contractor with the U.S. Government and are required to comply with and will be affected by laws and regulations
relating to the award, administration and performance of U.S. Government contracts. Government contract laws and regulations
affect how we will do business with customers, and in some instances, will impose added costs on our business. A violation
of specific laws and regulations could result in the imposition of fines and penalties, the termination of any then existing contracts,
or the inability to bid on future contracts. For further discussion of the risks relating to U.S. Government contracts and
FAA rules and regulations, see “Item 1A. Risk Factors” of this Annual Report. For further discussion about our dependence
on a few major customers see Note 13 – Concentrations in the Notes.

International
sales of our products may also be subject to U.S. laws, regulations and policies like the U.S. Department of State restrictions
on the transfer of technology, International Traffic in Arms Regulations (“ITAR”) and other export laws and regulations
and may be subject to first obtaining licenses, clearances or authorizations from various regulatory entities. This
may limit our ability to sell our products abroad and the failure to comply with any of these regulations could adversely affect
our ability to conduct business and generate revenues as well as increase our operating costs. Our products may also
be subject to regulation by the National Telecommunications and Information Administration and the Federal Communications Commission,
which regulate wireless communications.

Sources
and Availability of Components

Certain
materials and equipment for our products are custom made for those products and are available only from a limited number of suppliers.
Failure of a supplier could cause delays in delivery of the products if another supplier cannot promptly be found or if the quality
of such replacement supplier’s components is inferior or unacceptable.For further discussion of the risks
relating to sources and availability of components, see “Item 1A. Risk Factors” of this Annual Report.

Employees

We
have 21 full-time and two part-time employees. Our executive management and accounting team are comprised of four of those full-time
employees and two part-time consultants. We have no labor union contracts and believe relations with our employees are satisfactory.

Recent
Developments

☐

On
March 1, 2017, we announced the successful integration of government-furnished ISR equipment supporting the simultaneous use
of communications and optical payload packages onto an enhanced WASP aerostat for the Department of Defense.

☐

On
January 12, 2017, we announced that David V. Aguilar, former Deputy Commissioner of U.S. Customs and Border Protection was
appointed to our Board of Directors.

☐

On
December 16, 2016, we announced that Lt. General Michael T. Flynn (Ret). resigned from our Board of Directors and Strategic
Advisory Board effective December 31, 2016 due to his appointment as National Security Advisor by President Donald Trump.

☐

On
December 14, 2016, we announced that Bruce Hardy was appointed to the newly-created position of Vice President of Sales.

☐

On
November 15, 2016, Infor announced a partnership with us for the creation of Infor’s new Drone Enterprise Asset Management
Solution designed to solve industry challenges by enabling safe, efficient asset management and maintenance.

☐

On
October 5, 2016, we announced that we were awarded US Patent 9,446,858 by the USPTO for the ETAP technologies currently utilized
in our WATT and BOLT tethered drone products.

6

Item
1A. Risk Factors

Investors
should carefully consider the risks described below as well as other information provided in this Annual Report. The Company’s
business, financial condition, results of operations and cash flows could be materially adversely affected, the value of the Company’s
common stock could decline, and investors may lose all or part of their investment as a result of these risks.

Risks
Related to Our Business and Industry

Product
development is a long, expensive and uncertain process.

The
development of LTA aerostats and tethered drone ISR systems is a costly, complex and time-consuming process, and the investment
in product development often involves a long wait until a return, if any, is achieved on such investment. We continue
to make significant investments in research and development relating to our aerostats and tethered drones. Investments
in new technology and processes are inherently speculative. Technical obstacles and challenges we encounter in our research and
development process may result in delays in or abandonment of product commercialization, may substantially increase the costs
of development, and may negatively affect our results of operations.

Successful
technical development of our products does not guarantee successful commercialization.

Even
if we successfully complete the technical development for one or all of our product development programs, we may still fail to
develop a commercially successful product for a number of reasons, including, among others, the following:

●

failure
to obtain the required regulatory approvals for their use;

●

prohibitive
production costs;

●

competing
products;

●

lack
of innovation of the product;

●

continuing
technological changes in the market rendering the product obsolete;

demonstrations
of the products not aligning with or meeting customer needs.

Although
we have sold our WASP aerostat systems and various other aerostat ISR systems and components, our success in the market for the
products we develop will depend largely on our ability to prove our products’ capabilities. Upon demonstration,
our aerostats and tethered drones may not have the capabilities they were designed to have or that we believed they would have. Furthermore,
even if we do successfully demonstrate our products’ capabilities, potential customers may be more comfortable doing business
with a larger, more established, more proven company than us. Moreover, competing products may prevent us from gaining wide market
acceptance of our products. We may not achieve significant revenue from new product investments for a number of years,
if at all.

7

Our
potential customers are likely to be U.S. Government or Government-related entities that are subject to appropriations by Congress
and reduced funding for defense procurement and research and development programs would likely adversely impact our ability to
generate revenues.

We
anticipate that the majority of our revenue (to be derived from our aerostats and tethered drone sales) at least in the foreseeable
future will come from U.S. Government and Government-related entities, including the DoD and other departments and agencies. Government
programs that we may seek to participate in, and contracts for aerostats or tethered drones, must compete with other programs
for consideration during Congress’ budget and appropriations hearings, and may be affected by changes not only in political
power and appointments but also general economic conditions and other factors beyond our control. A government closure
based on a failure of Congress to agree on federal appropriations or the uncertainty surrounding a continuing resolution may result
in termination or delay of federal funding opportunities we are pursuing. Reductions, extensions or terminations in a program
that we are seeking to participate in or overall defense or other spending could adversely affect our ability to generate revenues
and realize any profits. We cannot predict whether potential changes in security, defense, communications and intelligence
priorities will afford opportunities for our business in terms of research and development or product contracts, but any reduction
in government spending on such programs could negatively impact our ability to generate revenues. In addition, our ability to
participate in U.S. Government programs may be affected by the adoption of new laws or regulations relating to Government contracting
or changes in existing laws or regulations, changes in political or public support for security and defense programs, and uncertainties
associated with the current global threat environment and other geo-political matters.

Some
of our products may be subject to governmental regulations pertaining to exportation.

International
sales of our products may be subject to U.S. laws, regulations and policies like ITAR and other export laws and regulations and
may be subject to first obtaining licenses, clearances or authorizations from various regulatory entities. If
we are not allowed to export our products or the clearance process is burdensome, our ability to generate revenue would be adversely
affected. The failure to comply with any of these regulations could adversely affect our ability to conduct our business
and generate revenues as well as increasing our operating costs.

We
compete with companies that have significantly more resources than we have and that already have received government contracts
for the development of aerostats and tethered drones.

A
number of our competitors have received considerable funding from government or government-related sources to develop various
aerostats and tethered drones. Most of these organizations and many of our other competitors have greater financial,
technical, manufacturing, marketing and sales resources and capabilities than we do. Our products will compete not
only with other aerostats and tethered drones, but also with heavier-than-air fixed wing aircraft, manned aircraft, communications
satellites and balloons. We anticipate increasing competition as a result of defense industry consolidation, which
has enabled companies to enhance their competitive position and ability to compete against us. In addition, other companies
may introduce competing aerostats, tethered drones, or solutions based on alternative technologies that may adversely affect our
competitive position. As a result, our products may become less or non-competitive or obsolete. If we are
not able to compete successfully against our current and future competitors, we may fail to generate revenues and our financial
condition would be adversely affected.

We
may pursue strategic transactions in the future, which could be difficult to implement, disrupt our business or change our business
profile significantly.

We
intend to consider potential strategic transactions, which could involve acquisitions of businesses or assets, joint ventures
or investments in businesses, products or technologies that expand, complement or otherwise relate to our current or future business.
We may also consider, from time to time, opportunities to engage in joint ventures or other business collaborations with third
parties to address particular market segments. These activities create risks such as, among others: (i) the need to integrate
and manage the businesses and products acquired with our own business and products, (ii) additional demands on our resources,
systems, procedures and controls, (iii) disruption of our ongoing business, and (iv) diversion of management’s
attention from other business concerns. Moreover, these transactions could involve: (a) substantial investment of funds or
financings by issuance of debt or equity securities; (b) substantial investment with respect to technology transfers and
operational integration; and (c) the acquisition or disposition of product lines or businesses. Also, such activities could
result in one-time charges and expenses and have the potential to either dilute the interests of existing shareholders or result
in the issuance of or assumption of debt. Such acquisitions, investments, joint ventures or other business collaborations may
involve significant commitments of financial and other resources of our company. Any such activity may not be successful in generating
revenue, income or other returns to us, and the resources committed to such activities will not be available to us for other purposes.
Moreover, if we are unable to access capital markets on acceptable terms or at all, we may not be able to consummate acquisitions
or may have to do so on the basis of a less than optimal capital structure. Our inability to: (i) take advantage of growth
opportunities for our business or for our products or (ii) address risks associated with acquisitions or investments in businesses
may negatively affect our operating results. Additionally, any impairment of goodwill or other intangible assets acquired in an
acquisition or in an investment or charges to earnings associated with any acquisition or investment activity may materially reduce
our earnings. These future acquisitions or joint ventures may not result in their anticipated benefits, and we may not
be able to properly integrate acquired products, technologies or businesses with our existing products and operations or combine
personnel and cultures. Failure to do so could deprive us of the intended benefits of those acquisitions.

8

If
we fail to protect our intellectual property rights, we could lose our ability to compete in the marketplace.

Our
intellectual property and proprietary rights are important to our ability to remain competitive and for the success of our products
and our business. Patent protection can be limited and not all intellectual property is or can be patented. We rely on a combination
of patent, trademark, copyright, and trade secret laws as well as confidentiality agreements and procedures, non-competition agreements
and other contractual provisions to protect our intellectual property, other proprietary rights and our brand. We have
little protection when we must rely on trade secrets and nondisclosure agreements. Our intellectual property rights
may be challenged, invalidated or circumvented by third parties. We may not be able to prevent the unauthorized disclosure or
use of our technical knowledge or other trade secrets by employees or competitors. Furthermore, our competitors may independently
develop technologies and products that are substantially equivalent or superior to our technologies and/or products, which could
result in decreased revenues for us. Moreover, the laws of foreign countries may not protect our intellectual property
rights to the same extent as the laws of the U.S. Litigation may be necessary to enforce our intellectual property rights, which
could result in substantial costs to us and substantial diversion of management attention. If we do not adequately protect our
intellectual property, our competitors could use it to enhance their products. Our inability to adequately protect
our intellectual property rights could adversely affect our business and financial condition and the value of our brand and other
intangible assets.

If
we fail to protect our intellectual property rights, our ability to pursue the development of our technologies and products would
be negatively affected.

Our
success will depend in part on our ability to obtain patents and maintain adequate protection of our intellectual property and
technologies. Some foreign countries lack rules and methods for defending intellectual property rights and do not protect proprietary
rights to the same extent as the United States. We have not filed for any patent protection rights outside the United States,
and many companies have had difficulty protecting their proprietary rights in foreign countries. We may not be able to prevent
misappropriation of our proprietary rights.

The
patent process is subject to numerous risks and uncertainties and there can be no assurance that we will be successful in protecting
our technologies by obtaining and enforcing patents. These risks and uncertainties include the following: patents that may be
issued or licensed may be challenged, invalidated, or circumvented, or otherwise may not provide any competitive advantage; our
competitors, many of which have substantially greater resources than us and many of which have made significant investments in
competing technologies, may seek, or may already have obtained, patents that will limit, interfere with, or eliminate our ability
to make, use, and license our technologies either in the United States or in international markets; there may be significant pressure
on the United States government and other international governmental bodies to limit the scope of patent protection both inside
and outside the United States for technologies that prove successful as a matter of public policy regarding security concerns;
countries other than the United States may have less restrictive patent laws than those upheld by United States courts, allowing
foreign competitors the ability to exploit these laws to create, develop, and market competing products.

Moreover,
any patents issued to us may not provide us with meaningful protection, or others may challenge, circumvent or narrow our patents.
Third parties may also independently develop technologies similar to ours or design around any patents on our technologies.

9

In
addition, the USPTO and patent offices in other jurisdictions have often required that patent applications concerning software
inventions be limited or narrowed substantially to cover only the specific innovations exemplified in the patent application,
thereby limiting the scope of protection against competitive challenges. Thus, even if we or our licensors are able to obtain
patents, the patents may be substantially narrower than anticipated.

Our
success depends on our patents, patent applications that may be licensed exclusively to us, and other patents to which we may
obtain assignment or licenses. We may not be aware, however, of all patents, published applications, or published literature that
may affect our business by blocking our ability to commercialize our products, by preventing the patentability of future products
or services to us or our licensors, or by covering the same or similar technologies that may invalidate our patents, limit the
scope of our future patent claims or adversely affect our ability to market our products and services.

In
addition to patents, we rely on a combination of trade secrets, confidentiality, nondisclosure and other contractual provisions,
and security measures to protect our confidential and proprietary information. These measures may not adequately protect our trade
secrets or other proprietary information. If they do not adequately protect our rights, third parties could use our technology,
and we could lose any competitive advantage we may have. In addition, others may independently develop similar proprietary information
or techniques or otherwise gain access to our trade secrets, which could impair any competitive advantage we may have.

Patent
protection and other intellectual property protection are crucial to the success of our business and prospects, and there is a
substantial risk that such protections will prove inadequate.

Other
companies may claim that we infringe their intellectual property, which could materially increase our costs and harm our ability
to generate future revenue and profit.

We
do not believe our product technologies infringe the proprietary rights of any third party, but claims of infringement are becoming
increasingly common and third parties may assert infringement claims against us. It may be difficult or impossible
to identify, prior to receipt of notice from a third party, the trade secrets, patent position or other intellectual property
rights of a third party, either in the United States or in foreign jurisdictions. Any such assertion may result in litigation
or may require us to obtain a license for or otherwise restrict our use of the intellectual property rights of third parties. If
we are required to obtain licenses to use any third-party technology, we would have to pay royalties, which may significantly
reduce any profit on our products. In addition, any such litigation could be expensive and disruptive to our ability
to generate revenue or enter into new market opportunities. If any of our products are found to infringe other parties’
proprietary rights and we are unable to come to terms regarding a license with such parties, we may be forced to modify our products
to make them non-infringing or to cease production of such products altogether.

The
nature of our business involves significant risks and uncertainties that may not be covered by insurance or indemnity.

We
develop and sell products where insurance or indemnification may not be available, including:

●

Designing
and developing products using advanced and unproven technologies and aerostats and tethered drones in intelligence and homeland
security applications that are intended to operate in high demand, high risk situations; and

●

Designing
and developing products to collect, distribute and analyze various types of information.

Failure
of certain of our products could result in loss of life or property damage. Certain products may raise questions with respect
to issues of civil liberties, intellectual property, trespass, conversion and similar concepts, which may raise new legal issues. Indemnification
to cover potential claims or liabilities resulting from a failure of technologies developed or deployed may be available in certain
circumstances, but not in others. We are not able to maintain insurance to protect against all operational risks and
uncertainties. Substantial claims resulting from an accident, failure of our product, or liability arising from our products
in excess of any indemnity or insurance coverage (or for which indemnity or insurance is not available or was not obtained) could
harm our financial condition, cash flows, and operating results. Any accident, even if fully covered or insured, could negatively
affect our reputation among our customers and the public, and make it more difficult for us to compete effectively.

10

If
critical components or raw materials used to manufacture our products become scarce or unavailable, then we may incur delays in
manufacturing and delivery of our products, which could damage our business

We
rely on a limited number of suppliers for the raw materials and hardware components necessary to manufacture our products. We
do not have any long-term agreements with any of our suppliers that obligate them to continue to sell their products to us. Our
reliance on these suppliers involves significant risks and uncertainties as to whether our suppliers will provide an adequate
supply of required raw materials, component parts, and products. In addition, as the demand for these components and other products
increases, it is likely that the price for these components will increase. If we are unable to obtain the raw materials and component
parts in the quantities and the quality we require on a timely basis and at acceptable prices, we may not be able to deliver our
products on a timely or cost-effective basis, which could cause our customers to terminate their contracts with us, increase our
costs and materially harm our business, results of operations, and financial condition. Furthermore, if our suppliers are unable
or unwilling to supply the raw materials or components we require, we will be forced to locate alternative suppliers and possibly
redesign our products to accommodate components from alternative suppliers. This would likely cause significant delays in manufacturing
and shipping our products to customers and could materially harm our business.

We
have limited experience manufacturing our products in high volumes and do not know whether or when we will be able to develop
efficient, low-cost manufacturing capabilities and processes that will enable us to manufacture our products in large quantities
while maintaining our quality, speed, price, engineering and design standards. Our inability to develop such manufacturing processes
and capabilities could have a material adverse effect on our business, financial condition, and results of operations. We expect
our suppliers to experience an increase in demand for their products, and we may not have reliable access to supplies that we
require and may not be able to purchase such materials or components at cost effective prices. There is no assurance that we will
obtain any material labor and machinery cost reductions associated with higher production levels, and failure to achieve these
cost reductions could adversely impact our business and financial results.

If
we are unable to recruit and retain key management, technical and sales personnel, our business would be negatively affected.

For
our business to be successful, we need to attract and retain highly qualified technical, management and sales personnel. The failure
to recruit additional key personnel when needed with specific qualifications and on acceptable terms or to retain good relationships
with our partners might impede our ability to continue to develop, commercialize and sell our products. To the extent the
demand for skilled personnel exceeds supply, we could experience higher labor, recruiting and training costs in order to attract
and retain such employees. The loss of any members of our management team may also delay or impair achievement of our business
objectives and result in business disruptions due to the time needed for their replacements to be recruited and become familiar
with our business. We face competition for qualified personnel from other companies with significantly more resources
available to them and thus may not be able to attract the level of personnel needed for our business to succeed.

Economic
conditions in the U.S. and worldwide could adversely affect our revenues.

Our
revenues and operating results depend on the overall demand for our technologies and services. If the U.S. and worldwide economies
weaken, either alone or in tandem with other factors beyond our control (including war, political unrest, shifts in market demand
for our services, actions by competitors, etc.), we may not be able to maintain or expand the growth of our revenue.

11

If
we are unable to obtain additional funding when needed, our business operations will be harmed, and if we do obtain additional
financing, our then existing shareholders may suffer substantial dilution.

Although
we believe we not currently require additional funds to sustain our operations and institute our business plan, we have historically
required additional funds to continue operations and may again in the future. We do not have any contracts or commitments
for additional funding, and there can be no assurance that financing will be available in amounts or on terms acceptable to us,
if at all, if needed. The inability to obtain additional capital will restrict our ability to grow and may reduce our ability
to conduct business operations. If we are unable to obtain additional financing to finance a revised growth plan, we will likely
be required to curtail such plans or cease our business operations. Any additional equity financing may involve substantial dilution
to our then existing shareholders.

Opportunities
for expanded uses of our products in the United States are limited by federal laws and rulemaking.

The
products we design and manufacture for use within the United States are limited by federal laws and rulemaking, including the
new commercial drone regulations (Part 107) adopted by the FAA at the end of August 2016. Our ability to design, manufacture and
release new products for use in the United States will be limited by federal law and regulations, which can be slow and subject
to delays based on political turnover and disruptions in federal funding, among other reasons. The Part 107 rules limit the altitude,
available airspace and weight of a drone and also the certification of remote pilots that can operate a drone for commercial purposes
in the United States. We, or our customers, may seek waivers from the Part 107 rules for expanded operations; however, the processing
of waivers is lengthy and uncertain. Political limits on the ability to issue new regulations could slow the growth of the aerostat
and tethered drone market.

Misuse
of our products or unmanned products manufactured by other companies could result in injury, damage and/or negative press that
could depress the market for unmanned systems.

If
any of our products are misused by our customers or their designees, or by the operators of other unmanned systems, in violation
of Part 107 or other federal, state or local regulations could result in injuries to the operators or bystanders, damage to property
and/or negative press that could result in a reduction in the market for aerostats or tethered drones in the future. The FAA,
the press and the public have been closely monitoring the growth of unmanned systems in the United States. For instance, the FAA
regularly publishes reports of drone sighting and reported drone strikes of manned aircraft. One or more incidents involving unmanned
systems that results in injury or death of individuals, or damaged property could result in negative press that could put at risk
current and future growth.

Our
business and operations are subject to the risks of hurricanes, tropical storms, and other natural disasters.

Our
corporate headquarters and manufacturing operations are located in Jacksonville, Florida, where major hurricanes, tropical storms,
and other severe weather conditions have occurred. A significant natural disaster, such as a hurricane, tropical storm, or other
severe weather storm could severely affect our ability to conduct normal business operations, and as a result, our future operating
results could be materially and adversely affected.

Risks
Relating to our Common Stock and its Market Value

The
price of our common stock may be volatile.

The
trading price of our common stock may be highly volatile and could be subject to fluctuations in response to a number of factors
beyond our control. Some of these factors are:

●

dilution
caused by our issuance of additional shares of common stock and other forms of equity securities, which we expect to make
in connection with future acquisitions and capital financings to fund our operations and growth, to attract and retain valuable
personnel and in connection with future strategic partnerships with other companies;

●

our
results of operations and the performance of our competitors;

●

the
public’s reaction to our press releases, our other public announcements and our filings with the Securities and Exchange
Commission (the “SEC”);

12

●

changes
in earnings estimates or recommendations by research analysts who follow, or may follow, us or other companies in our industry;

●

changes
in general economic conditions;

●

changes
in the valuation of similarly situated companies, both in our industry and in other industries;

●

actions
of our historical equity investors, including sales of common stock by our directors and executive officers;

●

actions
by institutional investors trading in our stock;

●

disruption
of our operations;

●

any
major change in our management team;

●

significant
sales of our common stock;

●

other
developments affecting us, our industry or our competitors; and

●

U.S.
and international economic, legal and regulatory factors unrelated to our performance.

These
and other factors are largely beyond our control, and the impact of these risks, individually or in the aggregate, may result
in material adverse changes to the market price of our common stock and/or our results of operations and financial condition.

There
is a limited market for our common stock, which may make it more difficult to dispose of our common stock.

Our
common stock is quoted on the OTCQX under the symbol “DRNE”. However, this is an unorganized, inter-dealer, over-the-counter
market which provides significantly less liquidity than the NASDAQ Capital Market or other national securities exchanges. These
factors may have an adverse impact on the trading and price of our common stock.

Sales
of substantial amounts of our common stock in the public market could harm the market price of our common stock.

The
sale of a substantial number of shares of our common stock by stockholders could adversely affect the market price of our common
stock. As of December 6, 2016, the date we held our Annual Shareholder Meeting, we had 112 stockholders of record and
approximately 5,600 beneficial owners, most of whom have held their shares for the required holding periods under Rule 144 promulgated
pursuant to the Securities Act and thus hold freely tradable shares. The shares issued pursuant to conversions under our
Series A, B, B-1, D, E, F and G Preferred Stock on November 20, 2015 and January 12, 2016 are now freely tradable pursuant to
Rule 144 promulgated pursuant to the Securities Act. If such shares are sold, or if it is perceived they will be sold, the trading
price of our common stock could decline. Because investors may be more reluctant to purchase shares of our common stock following
substantial sales or issuances, the resale of these shares of common stock could impair our ability to raise capital in the near
term.

We
have not paid dividends in the past and do not expect to pay dividends in the future. Any return on investment may be limited
to the value of our common stock.

We
have never paid cash dividends on our common stock and do not anticipate paying cash dividends in the foreseeable future. The
payment of dividends on our common stock will depend on our earnings, financial condition and other business and economic factors
affecting us at such time as our Board of Directors may consider relevant.

13

Our
common stock is subject to the “penny stock” rules of the SEC and the trading market in our securities is limited,
which makes transactions in our stock cumbersome and may reduce the value of an investment in our stock.

The
SEC has adopted Rule 15g-9 which establishes the definition of a “penny stock,” for the purposes relevant to us, as
any equity security that has a market price of less than $5.00 per share or with an exercise price of less than $5.00 per share,
subject to certain exceptions. For any transaction involving a penny stock, unless exempt, the rules require:

●

that
a broker or dealer approve a person’s account for transactions in penny stocks; and

●

that
the broker or dealer receive from the investor a written agreement to the transaction, setting forth the identity and quantity
of the penny stock to be purchased.

In
order to approve a person's account for transactions in penny stocks, the broker or dealer must:

●

obtain
financial information, investment experience, and investment objectives of the person; and

●

make
a reasonable determination that the transactions in penny stocks are suitable for that person and the person has sufficient
knowledge and experience in financial matters to be capable of evaluating the risks of transactions in penny stocks.

The
broker or dealer must also deliver, prior to any transaction in a penny stock, a disclosure schedule prescribed by the SEC relating
to the penny stock market, which, in highlight form:

●

sets
forth the basis on which the broker or dealer made the suitability determination;

●

that
it is unlawful for the broker or dealer to effect a transaction in a penny stock unless the broker or dealer has received
a signed, written agreement from the investor prior to the transaction; and

●

that
the broker dealer is required to provide the person with the foregoing written statement and that the person should not sign
the written statement unless it accurately reflects the person’s financial situation, investment experience, and investment
objectives.

Generally,
brokers may be less willing to execute transactions in securities subject to the "penny stock" rules. This may make
it more difficult for investors to dispose of our common stock and cause a decline in the market value of our stock.

FINRA sales
practice requirements may also limit a shareholder’s ability to buy and sell our stock.

In
addition to the “penny stock” rules described above, Financial Industry Regulatory Authority, Inc. (“FINRA”)
has adopted rules that require that in recommending an investment to a customer, a broker-dealer must have reasonable grounds
for believing that the investment is suitable for that customer. Prior to recommending speculative low priced securities to their
non-institutional customers, broker-dealers must make reasonable efforts to obtain information about the customer’s financial
status, tax status, investment objectives and other information. Under interpretations of these rules, FINRA believes that there
is a high probability that speculative low priced securities will not be suitable for at least some customers. The FINRA requirements
make it more difficult for broker-dealers to recommend that their customers buy our common stock, which may limit a stockholder’s
or investor’s ability to buy and sell our stock and have an adverse effect on the market for our shares.

14

Item
1B. Unresolved Staff Comments

None.

Item
2. Properties

Our
principal executive officer is located at 11651 Central Parkway #118, Jacksonville, Florida 32224. Several of our management employees
work remotely. We have entered into a 60-month operating lease for 5,533 square feet of office and manufacturing space at 11651
Central Parkway #118, Jacksonville, Florida 32224. The lease commenced February 1, 2015 and we took occupancy in June 2015. We
also lease an executive office in Aventura, Florida for an executive on a month-to-month basis.

Item
3. Legal Proceedings.

From
time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. We
are currently party to the following material legal proceeding:

On
May 16, 2016, Banco Popular North America (“Banco”) filed a lawsuit in Duval County, Florida in the Circuit Court
of the Fourth Judicial Circuit against Aerial Products, Kevin M. Hess, LTAS and the Company to collect on a delinquent Small Business
Administration loan that Banco made in 2007 to Aerial Products with Mr. Hess as the personal guarantor. LTAS and the Company filed
an Answer on June 30, 2016. It is our position that neither LTAS nor the Company are continuations of Aerial Products and we have
denied all allegations made by Banco and will vigorously defend that position. The Company has evaluated the probability of loss
as possible but the range of loss is unable to be estimated.

Other
than as set forth above, there are no pending material claims, actions, suits, proceedings, inquiries, labor disputes or investigations
involving the Company.

The
Company’s common stock has been quoted on the OTCQX under the ticker symbol “DRNE” since January 6, 2016, and
previously was quoted on the OTCQB under the ticker symbol “DRNE” and the OTC Pink under the ticker symbol “MCVE.”

The
following sets forth the range of the bid prices for our common stock for the quarters for the prior two fiscal years. Such prices
represent inter-dealer quotations, do not represent actual transactions, and do not include retail mark-ups, markdowns or commissions.
Such prices were determined from information provided by a majority of the market makers for the Company’s common stock.

2016

2015

Bid Price

Bid Price

High

Low

High

Low

Quarter Ended

March 31

$

3.60

$

2.30

$

24.00

$

9.20

June 30

3.25

2.67

14.40

8.40

September 30

4.45

2.80

11.60

6.00

December 31

3.35

2.61

6.80

3.12

Holders

As
of March 17, 2017, there were approximately 112 stockholders of record, according to the records of our transfer agent, and approximately
5,600 beneficial owners, of the Company’s common stock.

Dividends

We
have not declared any common stock dividends to date. We have no present intention of paying any cash dividends on our common
stock in the foreseeable future, as we intend to use earnings, if any, to generate growth. The payment by us of dividends, if
any, in the future, is within the discretion of our Board of Directors and will depend upon, among other things, our earnings,
capital requirements and financial condition, as well as other relevant factors. There are no material restrictions in our Articles
of Incorporation, as amended, or Bylaws that restrict us from declaring dividends.

Recent
Sales of Unregistered Securities

All
sales of unregistered securities during the period covered by this Annual Report have been previously disclosed.

Item
6. Selected Financial Data.

Not
required under Regulation S-K for smaller reporting companies.

16

Item
7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Introduction

The
following management discussion and analysis of financial condition and results of operations (this “MD&A”) should
be read in conjunction with our Consolidated Financial Statements and the notes to those statements (the “Notes”)
that appear elsewhere in this Annual Report. Except for the historical information contained therein, the discussions
in this MD&A contain forward-looking statements based upon current expectations that involve risks and uncertainties, such
as plans, strategies, objectives, expectations and intentions. Actual results and the timing of events could differ
materially from those anticipated in these forward-looking statements as a result of a number of factors, including those set
forth under “Item 1A. Risk Factors” and elsewhere in this Annual Report.

Business
Overview

For
this information please see “Item 1. Business” of this Annual Report. The information regarding an overview of our
business is set forth under “Item 1. Business—Business Overview” of this Annual Report and is incorporated into
this MD&A by this reference.

Results
of Operations

Year
Ended December 31, 2016 Compared to Year Ended December 31, 2015

Total
Net Revenues: Total net revenues increased $996,303, or 211%, to $1,468,462 in 2016 from $472,159 in 2015. Sources of revenue
in 2016 were derived primarily from sales of larger tethered aerostat systems, upgrades to customer aerostat systems and the first-time
sale of tethered multi-rotor drones. The Company anticipates an increased demand for a similar product mix in 2017. Sources of
revenue in 2015 primarily consisted of sales of small aerostat systems.

Cost
of Goods Sold and Gross Profit: Cost of goods sold for 2016 increased $274,972, or 97%, from $282,753 in 2015 to
$557,725 in 2016, primarily consisting of materials, parts and labor associated with the sale of aerostat systems, refurbishment
of aerostat systems and sale of tethered drones. We expect our cost of goods sold to increase as our revenues continue to increase.
The resulting gross profit for 2016 of $910,737 was an increase of $721,331, or 381%, from the gross profit for 2015 of $189,406
driven primarily by the increase in net revenue. Gross profit margins were 62% and 40% for 2016 and 2015, respectively. The margins
on large aerostat systems are greater than the smaller systems sold in 2015 due to labor efficiencies and because the cost of
materials does not significantly increase for large aerostat systems, and the margins on the first sales in 2016 of tethered drones
were also favorable. Margins also vary based on customer payload selection; therefore, future margins may vary accordingly.

General
and Administrative Expenses: General and administrative (“G&A”) expense increased by $568,663, or 6%, to $9,732,219
in 2016 from $9,163,556 in 2015. The Company invested $1,218,614 in research and development, primarily related
to multi-rotor tethered drone products, an increase of $474,162 from the investment of $744,452 in 2015. The engineering staff
was increased by four during 2016 and development began on several new products. The Company anticipates developing additional
products based on past research and development efforts; therefore, future research and development costs could be lower. Executive
salaries increased $67,500 in 2016 and executive bonuses increased $216,938, including $195,000 in bonuses accrued in 2016 and
paid in 2017. Professional fees, including legal and accounting fees, increased by $48,288 primarily related to general corporate,
securities and fundraising matters. Marketing and advertising expenses increased by $43,513 primarily related to expanding product
awareness through print media and consulting arrangements. Depreciation expense increased $13,833 primarily due to increased investments
in manufacturing equipment. Amortization expense increased $132,398 primarily due to our acquisition of the assets of Adaptive
Flight, Inc. (“AFI”) in 2015. Stock based compensation, a non-cash expense, decreased by $381,962.

Loss
from Operations: Loss from operations for 2016 of $8,821,482 was a decrease of $152,668, or 2%, less than the loss from operations
in 2015 of $8,974,150. The decrease was primarily due to an increase in gross profit of $721,331 and an increase of G&A expenses
of $568,663.

Other
Income and Expense: Total other income of $287,967 in 2016 was $289,967, or $16,920%, greater than the total other expense
of $1,712 in 2015. This change was primarily due to a $562,961 non-cash income for derivative accounting under Financial
Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 815-15, “Derivative
and Hedging,” and $75,000 of income from debt forgiveness related to the settlement of the loan from the Oklahoma Technology
Commercialization Center (“OTCC”) partially offset by an increase of $348,090 in accrued interest expense on the related
party convertible notes payable. The Company will continue to incur interest expense in 2017 on the related party convertible
notes payable and will continue to record derivative gains or losses related to those notes until they are repaid.

17

Net
Loss: Net loss of $8,533,515 in 2016 was $442,347, or 5%, less than the net loss in 2015 of $8,975,862 primarily due to the
factors discussed above.

There
was no provision for income taxes for the fiscal years ended 2016 and 2015 due to a valuation allowance of $2,574,915 and $1,434,996
recorded for the years ended December 31, 2016 and 2015, respectively, on the total tax provision, because we believed that it
is more likely than not that the tax asset will not be utilized during the next year.

Liquidity
and Capital Resources

As
of December 31, 2016, the Company had total current assets of $2,989,713 and total current liabilities of $3,080,628 for a working
capital deficit of $90,915. As of December 31, 2016, the Company had cash and cash equivalents of $2,015,214 and an accumulated
deficit of $19,672,785 since operations commenced in April 2014.

Although
there was a net loss of $8,533,515 in 2016, the Company’s independent registered public accounting firm’s audit report
for the year ended December 31, 2016, included with this Annual Report, does not contain a qualified opinion or an explanatory
paragraph regarding the Company’s ability to continue as a going concern. The accompanying consolidated financial statements
have been prepared assuming that the Company continues as a going concern and contemplates the realization of assets and the satisfaction
of liabilities in the normal course of business. The ability of the Company to continue as a going concern on a long-term basis
will be dependent upon its ability to create and market innovative products and to sustain adequate working capital to finance
its operations.

We
have historically financed our operations through operating revenues and sales of equity securities, and most recently through
sales of notes convertible into our equity securities, to accredited investors. While we currently believe we
have sufficient capital to continue our operations for the next 12 months, we may incur greater expenses than we currently anticipate. As
a result, we could deplete our cash and working capital more rapidly than expected, which could result in our need to raise
additional working capital through sale of equity securities or debt financing.

Sources
and Uses of Cash

Years Ended Dec 31,

2016

2015

Cash flows (used in) operating activities

$

(3,593,184

)

$

(2,865,685

)

Cash flows (used in) investing activities

(16,336

)

(329,227

)

Cash flows provided by financing activities

2,965,000

4,484,750

Net (decrease) increase in cash and cash equivalents

$

(644,520

)

$

1,289,838

Operating
Activities:

Net
cash used in operating activities during the year ended December 31, 2016 was $3,593,184, which was an increase of $727,499, or
25%, from $2,865,685 net cash used in operating activities during the year ended December 31, 2015. The increase in accounts receivable
of $310,712 and the increase in inventory of $341,090, which both related to increased sales activity in 2016, account for a significant
portion of the increase in cash used in operations. The Company expects the carrying costs of accounts receivable and inventory
to increase in 2017 in line with anticipated increased revenues.

18

Investing
Activities:

Net
cash used in investing activities during the year ended December 31, 2016 was $16,336, which was a decrease of $312,891, or 95%,
from $329,227 net cash used in investing activities during the year ended December 31, 2015. In 2016, the Company purchased $16,336
in furniture and equipment. In 2015, the Company purchased $129,227 in furniture and equipment and expended $200,000 on the AFI
asset acquisition. The Company expects the investment in furniture and equipment in 2017 to be no greater than the investment
in furniture and equipment in 2015, but we can give no assurance that such furniture and equipment costs will remain within that
range in 2017.

Financing
Activities:

Net
cash provided by financing activities was $2,965,000 in 2016 compared with $4,484,750 cash provided by financing activities for
the same period in 2015, a decrease of $1,519,750, or 34%. In 2016, the Company received $3,000,000 in proceeds from
related party convertible notes payable and paid $35,000 to pay off the OTCC loan. In 2015, the Company received $3,484,750 cash
proceeds from the sale of common stock for cash as well as $1,000,000 cash proceeds from the sale of Series G preferred stock.

During
2016, the Company experienced negative cash flow from operations. Significant negative cash flow from operations is likely to
occur in 2017 as the Company continues developing multi-rotor tethered drone products and marketing its aerostat and multi-rotor
drone products. Although we currently have adequate funds to sustain our operations in the near term, we may require additional
funds to continue operations depending upon the level of interest in the Company’s new and existing product offerings. We
have no immediate plans to raise additional funds; however, if we need to raise additional funds through the issuance of equity,
equity-related or convertible debt securities in the future, these securities may have rights, preferences or privileges senior
to those of the rights of holders of our common stock. We cannot predict whether additional financing will be available to us
on favorable terms when required, or at all. The issuance of additional common stock may have the effect of further diluting the
proportionate equity interest and voting power of holders of our common stock. Historically, we have financed our cash
needs by private placements of our securities. There is no assurance that we will be able to obtain financing on terms consistent
with our past financings or satisfactory to us, if at all.

As
of December 31, 2016, the Company has common stock outstanding, as well as Series A Convertible Preferred Stock, and Convertible
Notes payable to related persons of the Company.

Off-Balance
Sheet Arrangements

We
do not have any off balance sheet arrangements that have had or are reasonably likely to have a current or future material effect
on our financial condition, changes in financial condition, revenues, expenses, results of operations, liquidity, capital expenditures
or capital resources.

Critical
Accounting Policies and Estimates

The
following is not intended to be a comprehensive list of our accounting policies or estimates. Our significant accounting policies
are more fully described in Note 1–Summary of Significant Accounting Policies in the Notes. In preparing our financial
statements and accounting for the underlying transactions and balances, we apply our accounting policies and estimates as disclosed
in the Notes. We consider the policies and estimates discussed below as critical to an understanding of our financial statements
because their application places the most significant demands on our judgment, with financial reporting results dependent on estimates
about the effect of matters that are inherently uncertain and may change in subsequent periods. Specific risks for these critical
accounting estimates are described in the following paragraphs. The impact and any associated risks related to these estimates
on our business operations are discussed throughout this MD&A where such estimates affect our reported and expected financial
results. Preparation of this Annual Report requires us to make estimates and assumptions that affect the reported amount of assets
and liabilities, disclosure of contingent assets and liabilities at the date of our financial statements and the reported amounts
of revenue and expenses during the reporting period. Actual results may differ from those estimates.

Besides
estimates that meet the “critical” accounting estimate criteria, we make many other accounting estimates in preparing
our financial statements and related disclosures. All estimates, whether or not deemed critical, affect reported amounts of assets,
liabilities, revenue and expenses as well as disclosures of contingent assets and liabilities. Estimates are based on experience
and other information available prior to the issuance of the financial statements. Materially different results can occur as circumstances
change and additional information becomes known, including for estimates that we do not deem “critical.”

19

Accounts
Receivable and Credit Policies:

Accounts receivable-trade
consists of amounts due from the sale of tethered aerostats, accessories, spare parts, and customization and refurbishment of aerostats. Such
accounts receivable are uncollateralized customer obligations due under normal trade terms requiring payment within 30 days of
receipt of the invoice. We provide an allowance for doubtful accounts equal to the estimated uncollectible amounts based
on historical collection experience and a review of the current status of trade accounts receivable. At December 31,
2016 and 2015, none of the Company’s accounts receivable-trade was deemed uncollectible.

Revenue
Recognition and Unearned Income:

The
Company recognizes revenue when all four of the following criteria are met: (1) persuasive evidence of an arrangement exists;
(2) delivery has occurred and title has transferred or services have been rendered; (3) our price to the buyer is fixed or determinable;
and (4) collectability is reasonably assured. We record unearned revenue as a liability and their associated costs of sales as
work in process inventory. In 2015, the Company recognized $7,896 in revenue from a 2014 sale that was delivered in 2015. There
was a balance of $394,000 in accounts receivable at December 31, 2016 for sales on account.

Long-Lived
Assets:

We
account for long-lived assets in accordance with the provisions of ASC 360-10-35, “Impairment or Disposal of Long-lived
Assets.” This accounting standard requires that long-lived assets be reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount may not be recoverable. Recoverability of assets to be
held and used is measured by a comparison of the carrying amount of an asset to future undiscounted net cash flows expected to
be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment
charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. We acquired
the LTAS customer list in 2014. The fair value of the customer list was determined by using a discounted cash flow model and $135,550
was recorded on the date of business combination. We recorded $31,941 of amortization expense for the year ended December 31,
2014, leaving a remaining carrying amount of $103,609. We recorded another $37,935 amortization expense for the year ended December
31, 2015. After comparing the acquired customer list to the actual customers who placed orders following the acquisition of LTAS,
we determined that the customer list was impaired at December 31, 2015 and amortized the remaining balance of $65,674 in 2015.

On
July 20, 2015, we, through our wholly-owned subsidiary AFS, entered into an agreement to acquire exclusive commercial software
licenses for the “GUST” (Georgia Tech UAV Simulation Tool) autopilot system from AFI. Through the purchase of the
assets of AFI, we assumed the transferable licenses from the Georgia Tech Research Corporation, which include flight simulation
tools and fault tolerant flight control algorithms. In addition, we acquired AFI’s dedicated flight computer and additional
related hardware and airframes. We paid $100,000 in immediately available funds and $100,000 to be held in escrow. In addition,
we issued 150,000 shares of unregistered common stock valued at $8.40 per share, on a post-reverse split basis, on the closing
date of the acquisition, to be held in escrow. We issued 50,000 shares of common stock to AFI in the second quarter of 2016 after
all milestones had been met as a requirement of the terms of the acquisition because the value of the escrowed shares fell below
$1,400,000 and triggered a ‘make whole’ provision. The asset acquisition with AFI did not qualify as a business combination
under ASC 805-10, “Business Combinations,” and has been accounted for as a regular asset purchase.

We
account for goodwill and intangible assets in accordance with ASC 350, ”Intangibles-Goodwill and Other.” ASC 350 requires
that goodwill and other intangibles with indefinite lives be tested for impairment annually or on an interim basis if events or
circumstances indicate that the fair value of an asset has decreased below its carrying value.

20

Derivative
Financial Instruments:

We
evaluate our financial instruments to determine if such instruments are derivatives or contain features that qualify as embedded
derivatives. For derivative financial instruments that are accounted for as liabilities, the derivative instrument is initially
recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value reported in the statements
of operations. For stock-based derivative financial instruments, we use a Black-Scholes option pricing model, in accordance with
ASC 815-15, “Derivative and Hedging,” to value the derivative instruments at inception and on subsequent valuation
dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities or as
equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance sheet
as current or non-current based on whether or not net-cash settlement of the derivative instrument could be required within 12
months of the balance sheet date.

Stock-Based
Compensation:

We
account for stock-based compensation in accordance with ASC 718, “Compensation-Stock Compensation.” ASC 718 requires
companies to measure the cost of employee services received in exchange for an award of equity instruments, including stock options,
based on the grant-date fair value of the award and to recognize it as compensation expense over the period the employee is required
to provide service in exchange for the award, usually the vesting period.

Recently
Issued Accounting Pronouncements

Management
does not believe that any recently issued, but not effective, accounting standards, if currently adopted, would have a material
effect on the Company’s financial statements.

Item
7A. Quantitative and Qualitative Disclosures About Market Risk.

Not
required under Regulation S-K for smaller reporting companies.

Item
8. Financial Statements and Supplementary Data.

Our
consolidated financial statements, together with the independent registered public accounting firm report of MaloneBailey, LLP,
begin on page F-1 of this Annual Report.

Item
9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure.

None.

Item
9A.Controls and Procedures.

(a)
Evaluation of disclosure controls and procedures.

Our
management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of
our disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the “Exchange
Act”), as of the end of the period covered by this Annual Report. In designing and evaluating the disclosure controls and
procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives. In addition, the design of disclosure controls and procedures
must reflect the fact that there are resource constraints and that management is required to apply its judgment in evaluating
the benefits of possible controls and procedures relative to their costs.

21

Based
on management’s evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of December
31, 2016, due to the weakness in internal control over financial reporting described below, our disclosure controls and procedures
are not designed at a reasonable assurance level or effective to provide reasonable assurance that information we are required
to disclose in reports that we file or submit under the Exchange Act is recorded, processed, summarized, and reported within the
time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including
our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
As discussed below, we plan on increasing the size of our accounting staff at the appropriate time for our business and its size
to ameliorate our auditor’s concern that the Company does not effectively segregate certain accounting duties, which we
believe would resolve the material weakness in internal control over financial reporting and similarly improve disclosure controls
and procedures, but there can be no assurances as to the timing of any such action or that the Company will be able to do so.

(b)
Management’s Annual Report on Internal Control Over Financial Reporting.

Our
management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Exchange
Act Rule 13a-15(f). Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, conducted
an evaluation of the effectiveness of our internal control over financial reporting based on the criteria set forth in Internal
Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission.

Our
management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016.
Based on that assessment, our management determined that, as of December 31, 2016, the Company’s internal control over financial
reporting was not effective for the purposes for which it is intended. Specifically, management’s determination was based
on the following material weaknesses which existed as of December 31, 2016:

The
Company did not effectively segregate certain accounting duties due to the small size of its accounting staff.

A
material weakness is a deficiency, or a combination of control deficiencies, in internal control over financial reporting such
that there is a reasonable possibility that a material misstatement of our annual or interim consolidated financial statements
will not be prevented or detected on a timely basis. Notwithstanding the determination that our internal control over financial
reporting was not effective, as of December 31, 2016, and that there was a material weakness as identified in this Annual Report,
we believe that our consolidated financial statements contained in this Annual Report fairly present our financial position, results
of operations and cash flows for the years covered hereby in all material respects.

This
Annual Report does not include an attestation report by MaloneBailey LLP, our independent registered public accounting firm, regarding
internal control over financial reporting. As a smaller reporting company, our management's report was not subject
to attestation by our registered public accounting firm pursuant to rules of the SEC that permit us to provide only management’s
report in this Annual Report.

Changes
in internal control over financial reporting.

We regularly
review our system of internal control over financial reporting and make changes to our processes and systems to improve controls
and increase efficiency. Changes may include such activities as implementing new, more efficient systems, consolidating activities,
and migrating processes. In the prior year, we identified a material weakness related to not maintaining a fully-integrated financial
reporting system which has since been remediated. There were no changes in our internal control over financial reporting that
occurred during the three months ended December 31, 2016 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting. Although we plan to increase the size of our accounting staff at the appropriate
time for our business and its size to ameliorate our auditor’s concern that the Company does not effectively segregate certain
accounting duties, there can be no assurances as to the timing of any such action or that the Company will be able to do so.

Item
9B.Other Information.

None.

22

PART
III

Item
10. Directors, Executive Officers and Corporate Governance

The
following table sets forth the names and ages of the members of our Board of Directors and our executive officers and the positions
held by each. Our Board of Directors elects our executive officers annually by majority vote. Each director’s term continues
until his or her successor is elected or qualified at the next annual meeting, unless such director earlier resigns or is removed.

Jay
H. Nussbaum, 72, joined our Board of Directors on June 1, 2015 and was named Chief Executive Officer on April 26, 2016.
He has extensive executive experience and expertise in government and commercial sales and management. Mr. Nussbaum is the founder
of Agilex Technologies, Inc. and served as its Vice Chairman and Chief Operating Officer from 2006 to March 2015, when it was
acquired by Accenture Federal Services, a provider of mission and technology solutions to the national security, healthcare and
public sectors of the U.S. government. He previously served as Executive Vice President of Oracle Service Industries (“Oracle”),
under Oracle’s then Chairman and Chief Executive Officer Larry Ellison, where Mr. Nussbaum oversaw Government, Education,
Health, Communications, Utilities and Financial Services operations. He also served as Global Head of Sales, Marketing and Business
Development for Citigroup Global Transaction Services, and as President of Integrated Systems Operation at Xerox Corp. Mr. Nussbaum
has been a director of Grand Slam Acquisition Corp. since October 24, 2007, a director of Victory Acquisition Corp. since January
12, 2007 and a director at Agilex Technologies, Inc. since 2006. Mr. Nussbaum is a graduate of the University of Maryland with
a B.A. in Business. Mr. Nussbaum’s government and commercial sales and management experience qualifies him to serve on our
Board of Directors.

Kevin
Hess, 50, was appointed Chief Technology Officer on April 27, 2016. He served as Chief Executive Officer between October
2, 2015 and April 27, 2016. Upon the closing of the Share Exchange on June 3, 2014, he was appointed Director of Engineering.
Mr. Hess became one of our directors on October 2, 2015. Mr. Hess has more than 20 years of technology experience comprising electronic
systems design for DoD programs and image processing and analytics for companies such as Hughes, Kodak and Dainippon. Mr. Hess
has been integrally involved with LTAS as an engineer and consultant since its founding in 2009, overseeing the development of
its proprietary aerostat and drone products. As an IT executive at Fortune 250 companies, Mr. Hess performed lead roles in software
development, application architecture, mission-critical infrastructure, and multi-million dollar project sponsorship and oversight.
Mr. Hess continues to leverage his background and education in computer science, having attended the Harvard Business School’s
Program for Management Development to further his strong track record of technology innovation and financial management. Mr. Hess
brings his unique talents to the design, manufacturing and support of our solutions. Mr. Hess’s technology industry experience
qualifies him to serve on our Board of Directors.

23

Felicia
Hess, 49, was appointed Chief Executive Officer and one of our directors upon the closing of the Share Exchange on
June 3, 2014. She resigned those positions on October 2, 2015 and was appointed Chief Operating Officer that same day.
Ms. Hess founded and began serving as President and a director of LTAS in 2009. Ms. Hess continued serving as President and a
director of LTAS after it was sold in 2013 to World Surveillance Group Inc. (“WSGI”), a developer of lighter-than-air
aerostats and unmanned aerial systems, and continued serving as President and a director of LTAS after it was acquired from WSGI
by Drone Aviation Corp. until Drone Aviation Corp. merged with and into us. Ms. Hess leverages her background in marketing, web
site development and customer acquisition to further the Company’s growth strategies. Ms. Hess graduated from the University
of Virginia with a B.A. in Rhetoric and Communications.

Daniyel
Erdberg, 38, was appointed Chief Operating Officer upon the closing of the Share Exchange on June 3, 2014. He
resigned that position on October 2, 2015 and was appointed President that same day. Mr. Erdberg served as Director of Business
Development at WSGI, a developer of lighter-than-air aerostats and unmanned aerial systems, from 2010 through May 2014, where
he worked with LTAS and specialized in advanced, custom designed ISR solutions. Mr. Erdberg successfully worked with
LTAS's aerial surveillance solutions for various government and commercial customers. Over the past 14 years, Mr. Erdberg has
been involved in operations of companies in various sectors of technology, including software development, telecommunications,
wireless networking and unmanned aerial systems. Mr. Erdberg graduated from Florida International University with a B.A. in International
Business.

Kendall
W. Carpenter, CPA, CGMA, CMA, 61, joined MacroSolve in 2006 as Controller. She was promoted to Executive Vice
President and Chief Financial Officer in 2008 and transitioned to Drone Aviation in 2014. Ms. Carpenter is also the Corporate
Secretary and Treasurer. Ms. Carpenter’s previous experience includes Division Controller with Allied Waste Industries,
over 10 years of experience as the top financial officer of an enterprise software company with an international customer base
and over 8 years of public accounting experience. Ms. Carpenter graduated with a B.S. in Accounting from Oklahoma State University
and has earned the professional designations of Certified Public Accountant, Chartered Global Management Accountant and Certified
Management Accountant.

Wayne
Jackson, 86, was appointed our Chairman of the Board of Directors upon closing the Share Exchange on June 3, 2014. General
Jackson served as a director of WSGI from April 2009 until February 2015. General Jackson had a 37-year career with the United
States Army, Air Force and Navy, retiring from active duty in 1984. During his military career, General Jackson served in various
overseas theaters of operations and in a variety of assignments. He commanded Aviation, Civil Affairs, Infantry, Military Intelligence,
Signal Corps and Special Forces units, as well as holding two General Office Commands and a position as the Director of Counterintelligence
and Security, Headquarters Department of the Army. In addition, General Jackson served as Chief, Division of Probation Administrative
Office of the United States Court, Washington, D.C. General Jackson has been awarded the Parachute Badge, the Expert Infantry
Badge and the Master Aviator Badge. His decorations include the Distinguished Service Medal, the Meritorious Service Medal, the
Army Commendation Medal and several other military awards and decorations. General Jackson has remained an active member of the
defense and intelligence communities and contributes military experience relevant to our products and target customers. For these
reasons, we believe General Jackson has the requisite set of skills and experience to serve as a valuable member of our Board
of Directors and its committees on which he serves.

Michael
Haas, 30, served as our interim President from April 17, 2014 until June 3, 2014 and has served as a member of our Board
of Directors since April 17, 2014. Since April 2010, Mr. Haas has been an Assistant Vice President of Morningstar, Inc., in Horsham,
Pennsylvania. Between 2007 and 2010, Mr. Haas was an Associate at KPMG, LLP in Philadelphia, Pennsylvania. Mr.
Haas received his B.S. in Finance from Villanova University in 2007. Mr. Haas was chosen to be a member of our Board of Directors
based on his general corporate knowledge and finance and accounting experience.

David
Aguilar, 61, was appointed to our Board of Directors on January 9, 2017. Since February 2013, Mr. Aguilar has been a principal
at Global Security Innovation Strategies, LLC. In April 2010, Mr. Aguilar became Deputy Commissioner of U.S. Customs and Border
Protection (“CBP”) and, from December 2011 until his retirement in February 2013, he served as acting Commissioner
of CBP. From July 2004 to January 2010, he served as Chief of the U.S. Border Patrol within the CBP. As Acting Commissioner of
CBP, Mr. Aguilar took the helm of a workforce of 60,000 agents, officers, and other personnel with responsibility for strategic
planning and oversight of an annual budget of nearly $12 billion. Mr. Aguilar is a recipient of the 2005 President’s Meritorious
Excellence Award, and in 2008, was a recipient of the Presidential Rank Award. Prior to joining the CBP, Mr. Aguilar held a variety
of operational and administrative positions within the U.S. Board Patrol since entering duty in June 1978. Mr. Aguilar holds an
Associate’s Degree in Accounting from Laredo Community College and attended Laredo State University and the University of
Texas at Arlington. He is a graduate of the Senior Executive Fellows program at Harvard University’s John F. Kennedy School
of Government. Mr. Aguilar’s government and management experience qualifies him to serve on the board of directors.

24

All
executive officers are employed under agreements which run through December 31, 2018.

During
the fiscal year ended December 31, 2016, our Board of Directors held six meetings and approved certain actions by unanimous written
consent. We expect our directors to attend all meetings of the Board of Directors and the committees thereof on which such directors
serve and to spend the time needed to prepare for such meetings and meet as frequently as necessary to properly discharge their
responsibilities.

Board
Committees

Our
Board of Directors has two standing committees: an Audit Committee and a Compensation Committee. Our Board of Directors performs
the functions customarily performed by a nominating committee.

Audit
Committee

The
Board of Directors has adopted a written charter for the Audit Committee. Our Audit Committee is responsible for: (1) the integrity
of our financial reporting process, systems of internal controls, and financial statements and reports; (2) the compliance by
us with legal and regulatory requirements; and (3) the appointment, compensation and oversight of our independent auditor’s
preparation and issuance of an audit report or related work. A more detailed description of our Audit Committee’s purposes
and responsibilities is contained in its charter. The Audit Committee is comprised of Chairman Mike Haas, Jay Nussbaum
and General Wayne Jackson. Our Board of Directors has determined in its business judgment that, other than Mr. Nussbaum, all of
the members of our Audit Committee are independent within the meaning of the OTCQX Rules for U.S. Companies, the Sarbanes-Oxley
Act of 2002, and related SEC rules. Our Board of Directors has also determined in its business judgment that Mr. Haas, Chairman
of our Audit Committee, satisfies the “audit committee financial expert” criteria, as that term is defined by SEC
rules, and is independent of the Company. During the fiscal year ended December 31, 2016, our Audit Committee held no meetings
independent of the Board of Directors.

Compensation
Committee

Our
Board of Directors has adopted a written charter setting forth the authority and responsibilities of the Compensation Committee.
Our Compensation Committee has responsibility for assisting the Board of Directors in, among other things, evaluating and making
recommendations regarding the compensation of our executive officers and directors, assuring that the executive officers are compensated
effectively in a manner consistent with our stated compensation strategy, producing an annual report on executive compensation
in accordance with the rules and regulations promulgated by the SEC, periodically evaluating the terms and administration of our
incentive plans and benefit programs, and monitoring of compliance with the legal prohibition on loans to our directors and executive
officers. A more detailed description of our Compensation Committee’s purposes and responsibilities is contained in its
charter. The Compensation Committee is comprised of Chairman Wayne Jackson, Jay Nussbaum and Michael Haas. Our Board of Directors
has determined in its business judgment that a majority of our Compensation Committee is independent within the meaning of the
OTCQX Rules for U.S. Companies and SEC rules. During the fiscal year ended December 31, 2016, our Compensation Committee held
three meetings.

Board
Leadership Structure and Role in Risk Oversight

Our
Board of Directors is primarily responsible for overseeing our risk management processes. Our Board of Directors receives and
reviews periodic reports from management, auditors, legal counsel, and others, as considered appropriate regarding our Company’s
assessment of risks. The Board of Directors focuses on the most significant risks facing our Company and our Company’s general
risk management strategy, and also ensures that risks undertaken by our Company are consistent with the Board’s appetite
for risk. While the Board oversees our Company, our Company’s management is responsible for day-to-day risk management processes.
We believe this division of responsibilities is the most effective approach for addressing the risks facing our Company and that
our Board leadership structure supports this approach.

Section
16(a) Beneficial Owner Reporting Compliance

Because
we do not have a class of securities registered under Section 12 of the Exchange Act, our executive officers and directors and
beneficial owners of more than 10% of our common stock are not required to file reports pursuant to Section 16(a) of the Exchange
Act.

Code
of Ethics

The
Company has adopted a Code of Ethics and Business Conduct that applies to all of its directors, officers (including our principal
executive officer, principal financial officer, principal accounting officer or controller, and any person performing similar
functions) and employees. The Code of Ethics and Business Conduct is available on our website at ir.droneaviationcorp.com/governance-docs.

25

Item
11. Executive Compensation.

The
following table provides certain summary information concerning compensation awarded to, earned by or paid to the individuals
who served as our principal executive officer during fiscal 2016 and our two other most highly compensated officers in fiscal
2016.

Name and Principal Position

Year

Salary

($)

Bonus

($)

Stock

Awards

($)(5)

Option

Awards

($)(6)

All Other Compensation ($)

Total

($)

Jay Nussbaum,
Chief Executive Officer and Chairman (1),

2016

2015

48,001

28,000

75,000

0

2,796,750

2,219,000

0

109,038

0

0

2,919,751

2,356,038

Kevin Hess,

2016

200,000

50,000

145,500

0

13,762

409,262

Chief Technology Officer and Director (2)

2015

144,167

100,000

0

769,308

1,370

1,014,845

Felicia Hess,

2016

150,000

10,000

2,444,608

0

130,216

2,734,824

Chief Operating Officer (3)

2015

150,000

15,000

587,650

741,087

11,123

1,504,860

Daniyel Erdberg,

2016

147,500

50,000

1,826,413

0

99,115

2,123,028

President (4)

2015

140,000

100,000

587,650

755,198

500

1,583,348

(1)

Mr.
Nussbaum was appointed Chairman of our Board of Directors on June 1, 2015 and was named Chief Executive Officer on April
27, 2016.

For
service as Chief Executive Officer in 2016, Mr. Nussbaum received two awards of common stock. The first award of 450,000
shares of common stock was subject to performance-based vesting and fully vested on September 26, 2016. The shares were
valued at $2.91 per share, or $1,309,500, on the date of the award. The second award of 450,000 shares of common stock
is subject to performance-based vesting, which has not yet occurred. The shares were valued at $3.305 per share, or $1,487,250,
on the date of the award.

For
service as a director and Chairman of our Board of Directors in 2016, Mr. Nussbaum received a monthly director fee of
$4,000 pursuant to a Director Agreement entered into with the Company in June 2015, which totaled $48,000 in 2016. Mr.
Nussbaum was awarded a $75,000 bonus on December 6, 2016 which was accrued and paid in January 2017.

For
service as a director and Chairman of our Board of Directors in 2015, Mr. Nussbaum received 50,000 shares of common stock
(on a post-reverse split basis) subject to 24 months vesting with prorated forfeiture for early termination. The shares
were valued at $10.80 per share, or $540,000, on the date of the award. The Company recognized costs of $270,000 during
2016 and $157,000 during 2015 associated with this award. Mr. Nussbaum also received 250,000 shares of common stock (on
a post-reverse split basis) subject to performance-based vesting that fully vested on February 4, 2016. The shares were
valued at $6.716 per share, or $1,679,000, on the date of the award. Mr. Nussbaum also received a fully-vested award of
options under the 2015 Equity Incentive Plan to purchase 50,000 shares of common stock at an exercise price of $5.00 per
share valued at $109,038. The options expire on December 10, 2018. Additionally, Mr. Nussbaum received a monthly director
fee of $4,000 pursuant to his Director Agreement totaling $28,000 in 2015.

26

(2)

On
April 27, 2016, Mr. Hess resigned as Chief Executive Officer and was appointed Chief
Technology Officer. He previously served as Director of Engineering. Mr. Hess is also
a member of our Board of Directors, but receives no compensation for his service as a
director.

For
services as Chief Technology Officer and Chief Executive Officer in 2016, Mr. Hess received an award of 50,000 shares
of common stock subject to performance-based vesting that fully vested on September 26, 2016. The shares were valued at
$2.91 per share, or $145,500, on the date of the award. In addition to his annual salary, Mr. Hess received $11,946 for
withholding taxes paid on his award of common stock. Mr. Hess recognized additional compensation of $1,816 in 2016 for
personal use of a company vehicle, grossed up for taxes. Mr. Hess was awarded a $50,000 bonus on December 6,
2016 which was accrued and paid in January 2017.

For
services as Director of Engineering and Chief Executive Officer in 2015, Mr. Hess received a fully-vested award under
the 2015 Equity Incentive Plan of options to acquire 15,000 shares of common stock at an exercise price of $5.00 per share
valued at $$42,308 that expire December 10, 2018. Mr. Hess also received a fully-vested award of options to acquire 75,000
shares of common stock at an exercise price of $6.00 per share valued at $726,977 that expire May 18, 2018. Mr.
Hess recognized additional compensation of $1,370 in 2015 for personal use of company vehicle, grossed up for taxes.

(3)

Ms.
Hess was appointed Chief Executive Officer and a director of the Company on June 3, 3014.
On October 2, 2015, Ms. Hess resigned as Chief Executive Officer and director and was
appointed Chief Operating Officer. Ms. Hess did not receive any compensation for her
service as a director in 2015.

For
service as Chief Operating Officer in 2016, Ms. Hess received two common stock awards. The first award of 350,000 shares
of common stock was subject to performance-based vesting and fully vested on September 26, 2016. The shares were valued
at $2.91 per share, or $1,018,500, on the date of the award. The second award of 431,500 shares of common stock is subject
to performance-based vesting and has not yet vested. The shares were valued at $3.305 per share, or $1,426,108, on the
date of the award. In addition to her annual salary, Ms. Hess received a bonus of $115,971 for withholding taxes paid
in on her stock awards and additional compensation of $14,245 for the personal use of a company vehicle, grossed up for
taxes. Ms. Hess was awarded a $10,000 bonus on December 6, 2016 which was accrued and paid in January 2017.

For
service as Chief Executive Officer and Chief Operating Officer in 2015, Ms. Hess received an award of fully-vested options
under the 2015 Equity Incentive Plan to purchase 5,000 shares of common stock at an exercise price of $5.00 per share,
valued at $14,110, which expire on December 10, 2018. Ms. Hess also received an award of fully-vested options under the
2015 Equity Incentive Plan to purchase 75,000 shares of common stock at an exercise price of $6.00 per share, valued at
$726,977, which expire on May 18, 2018. Ms. Hess also received 87,500 shares of common stock subject to performance-based
vesting. The shares were valued at $6.716 per share, or $587,650, on the date of the award. Ms. Hess recognized additional
compensation of $11,123 in 2015 for personal use of a company vehicle, grossed up for taxes.

(4)

For service as President in 2016, Mr.
Erdberg received two stock awards. The first award of 250,000 shares of common stock was subject to performance-based vesting and
fully vested on September 26, 2016. The shares were valued at $2.91 per share, or $727,500, on the date of the award. The second
award of 332,500 shares of common stock remains subject to performance-based vesting. The shares were valued at $3.305 per share,
or $1,098,913, on the date of the award. In addition to his annual salary, Mr. Erdberg received a bonus of $93,115 for withholding
taxes paid on his stock awards and additional compensation of $6,000 for an auto allowance. Mr. Erdberg was awarded a $50,000 bonus
on December 6, 2016 which was accrued and paid in January 2017.

For service as Chief Operating Officer and President in 2015, Mr. Erdberg received a fully-vested award under
the 2015 Equity Incentive Plan of options to acquire 10,000 shares of common stock at an exercise price of $5.00 per share, valued
at $28,221, which expire December 10, 2018. Mr. Erdberg also received a fully-vested award under the 2015 Equity Incentive Plan
of options to acquire 75,000 shares of common stock at an exercise price of $6.00 per share, valued at $726,977, which expire May
18, 2018. For services in 2015, Mr. Edberg also received an award of 87,500 shares of common stock subject to performance-based
vesting, which have not yet vested. The shares were valued at $6.716 per share, or $587,650, on the date of the award. Mr. Erdberg
also received a $500 car allowance in December 2015.

27

(5)

Amounts
shown in the “Stock Awards” column reflect the aggregate grant date fair value calculated in accordance with
FASB ASC 718 for the respective fiscal year with respect to shares of restricted stock and immediately vested shares granted
to our named executive officers. Amounts reflect our accounting for these awards and do not necessarily correspond to
the actual values that may be realized by our named executive officers. The grant date fair values of shares of restricted
stock and immediately vested shares were determined as of the grant date using the closing bid price of our common stock
on the grant date. The assumptions used for the valuations are set forth in Note 7 – Shareholder Equity in
the Notes. Pursuant to SEC rules, we disregarded the estimates of forfeitures related to service-based vesting conditions.
See the Outstanding Equity Awards at Fiscal Year-End Table in this Annual Report and related notes for information with
respect to equity awards made prior to fiscal 2016.

(6)

Amounts
shown in the “Option Awards” column reflect the aggregate grant date fair value calculated in accordance with
FASB ASC 718 for the respective fiscal year with respect to stock options granted to our named executive officers. Amounts
reflect our accounting for these option grants and do not necessarily correspond to the actual values that may be realized
by our named executive officers. The grant date fair values of these option grants were calculated at the grant
date using the Black-Scholes-Merton option-pricing model. The assumptions used for the valuations are set forth
in Note 9 – Employee Stock Options in the Notes. Pursuant to SEC rules, we disregarded the
estimates of forfeitures related to service-based vesting conditions. See the Outstanding Equity Awards at Fiscal
Year-End Table in this Annual Report and related notes for information with respect to stock options granted prior to fiscal
2016.

Employment
Contracts and Potential Payments Upon Termination or Change in Control

Jay
Nussbaum Employment Agreement. On April 27, 2016, we entered into an Employment Agreement with Jay Nussbaum
(as amended, the “Nussbaum Employment Agreement”), whereby Mr. Nussbaum agreed to serve as our Chief Executive Officer
and a director (with such service as a director subject to the terms of a Director Agreement, dated June 1, 2015) for a period
of two (2) years and twenty-two (22) days, subject to renewal for successive one year terms, in consideration of an annual salary
of $1 base salary. Additionally, Mr. Nussbaum is eligible for an annual cash bonus if we meet or exceed criteria adopted by the
Compensation Committee of the Board of Directors. Mr. Nussbaum shall also be eligible for grants of awards under stock option
or other equity incentive plans of our Company as our Compensation Committee may from time to time determine and shall be entitled
to participate in all benefits plans we provide to our senior executives. We shall reimburse Mr. Nussbaum for all reasonable
out-of-pocket expenses actually incurred or paid by Mr. Nussbaum in the course of his employment. In the event Mr.
Nussbaum’s employment is terminated without Cause or by Mr. Nussbaum with Good Reason (as such terms are defined in the
Nussbaum Employment Agreement), then in addition to receiving accrued but unpaid compensation and vacation pay through the end
of the term of employment, benefits accrued and outstanding under benefit plans, and the reimbursement of documented, unreimbursed
expenses prior to the date of termination, Mr. Nussbaum will be entitled to receive severance benefits equal to six months of
his then-current base salary, continued coverage under our benefit plans for a period of twelve months and payment of his pro-rated
earned annual bonus. Mr. Nussbaum has also agreed to non-competition and non-solicitation provisions effective during his term
of employment and for one year thereafter. On September 26, 2016, the Company and Mr. Nussbaum amended the Nussbaum Employment
Agreement to extend the term of Mr. Nussbaum’s until December 31, 2018.

28

Kevin
Hess Employment Agreement. On October 2, 2015, we entered into an Amended and Restated Employment Agreement
with Kevin Hess (as further amended, the “K. Hess Employment Agreement”), whereby Mr. Hess agreed to serve as our
Chief Executive Officer for a period of two (2) years, subject to renewal for successive one year terms, in consideration for
an annual salary of $200,000. On April 27, 2016, the Company and Mr. Hess amended the K. Hess Employment Agreement to reflect
Mr. Hess’s appointment as Chief Technology Officer and extend the term of employment until May 18, 2018, which was further
extended to December 31, 2018 pursuant to a subsequent amendment to the K. Hess Employment Agreement. Additionally, Mr. Hess is
eligible for an annual cash bonus in an amount equal to up to one hundred percent (100%) of his then-current base salary if we
meet or exceed criteria adopted by the Compensation Committee of the Board of Directors. Mr. Hess shall also be eligible
for grants of awards under stock option or other equity incentive plans of our Company as our Compensation Committee may from
time to time determine and shall be entitled to participate in all benefits plans we provide to our senior executives. Mr.
Hess is also entitled to the use of a company-provided vehicle. We shall reimburse Mr. Hess for all reasonable out-of-pocket expenses
actually incurred or paid by Mr. Hess in the course of his employment. In the event Mr. Hess’ employment is terminated
without Cause or by Mr. Hess with Good Reason (as such terms are defined in the K. Hess Employment Agreement), Mr. Hess shall
be entitled to receive his accrued and unpaid base salary through the date of termination, continued coverage under our benefit
plans for a period of one months and reimbursement of documented, unreimbursed expenses incurred prior to the date of termination.
Mr. Hess has also agreed to non-competition and non-solicitation provisions effective during the term of his employment and for
one year thereafter.

Felicia
Hess Employment Agreement. On May 18, 2015, we entered into an employment agreement with Felicia Hess (as amended,
the “F. Hess Employment Agreement”), whereby Ms. Hess agreed to serve as our Chief Executive Officer and director
for a period of two (2) years, subject to renewal for successive one year terms, in consideration for an annual salary of $150,000.
On October 2, 2015, Ms. Hess resigned as Chief Executive Officer and as a director, and the F. Hess Employment Agreement was amended
to reflect Ms. Hess’s appointment as Chief Operating Officer. The F. Hess Employment Agreement was subsequently amended
to extend the term of Ms. Hess’s employment to December 31, 2018. Under the F. Hess Employment Agreement, Ms.
Hess is eligible for an annual cash bonus in an amount equal to up to one hundred percent (100%) of her then-current base salary
if we meet or exceed criteria adopted by the Compensation Committee of the Board of Directors. Ms. Hess shall also be eligible
for grants of awards under stock option or other equity incentive plans of our Company as our Compensation Committee may from
time to time determine and shall be entitled to participate in all benefits plans we provide to our senior executives. Ms.
Hess is also entitled to the use of a company-provided vehicle. We shall reimburse Ms. Hess for all reasonable out-of-pocket expenses
actually incurred or paid in the course of her employment. In the event Ms. Hess’ employment is terminated without
Cause or by Ms. Hess with Good Reason (as such terms are defined in the F. Hess Employment Agreement), ), then in addition to
receiving accrued but unpaid compensation and vacation pay through the end of the term of employment, benefits accrued and outstanding
under benefit plans, and the reimbursement of documented, unreimbursed expenses prior to the date of termination, Ms. Hess shall
be entitled to receive severance benefits equal to six months of her then-current base salary, continued coverage under our benefit
plans for a period of twelve months, payment of her pro-rated earned annual bonus, and the vesting of all unvested options or
restricted stock awards will be accelerated. Ms. Hess has also agreed to non-competition and non-solicitation provisions during
her term of employment and for one year thereafter.

Daniyel
Erdberg Employment Agreement. On May 18, 2015, we entered into an employment agreement with Daniyel Erdberg
(as amended, the “Erdberg Employment Agreement”), whereby Mr. Erdberg agreed to serve as our Chief Operating Officer
for a period of two (2) years, subject to renewal for successive one year terms, in consideration for an annual salary of $140,000. On
October 2, 2015, Mr. Erdberg resigned as Chief Operating Officer, and the Erdberg Employment Agreement was amended to reflect
his appointment as President of the Company. The Erdberg Employment Agreement was subsequently further amended to increase Mr.
Erdberg’s base salary to $150,000 and to extend his term of employment to December 31, 2018. Under the Erdberg Employment
Agreement, Mr. Erdberg is eligible for an annual cash bonus in an amount equal to up to one hundred percent (100%) of his then-current
base salary if we meet or exceed criteria adopted by the Compensation Committee of the Board of Directors. Mr. Erdberg shall also
be eligible for grants of awards under stock option or other equity incentive plans of our Company as the Compensation Committee
may from time to time determine and shall be entitled to participate in all benefits plans we provide to our executives. We
shall reimburse Mr. Erdberg for all reasonable out-of-pocket expenses actually incurred or paid in the course of his employment.
Mr. Erdberg was granted a $500 per month car allowance for the term of his employment by the Board of Directors in December 2015.
In the event Mr. Erdberg’s employment is terminated without Cause or by Mr. Erdberg with Good Reason (as such terms are
defined in the Erdberg Employment Agreement), , then in addition to receiving accrued but unpaid compensation and vacation pay
through the end of the term of employment, benefits accrued and outstanding under benefit plans, and the reimbursement of documented,
unreimbursed expenses prior to the date of termination, Mr. Erdberg shall be entitled to receive severance benefits equal to six
months of his then-current base salary, continued coverage under our benefit plans for a period of twelve months after his termination
date and payment of his pro-rated earned annual bonus. Mr. Erdberg has also agreed to non-competition and non-solicitation provisions
during the term of his employment and for one year thereafter.

29

Outstanding
Equity Awards at Fiscal Year-End

The
following table sets forth outstanding equity awards to our named executive officers as of December 31, 2016.

Option awards

Stock awards

Name

Number of securities underlying unexercised options (#) exercisable

Option
exercise
price ($)

Option
expiration date

Number of shares or units of stock that have not vested (#) (1)

Market value of shares of units of stock that have not vested ($) (2)

(a)

(b)

(e)

(f)

(g)

(h)

Jay Nussbaum

Option Grant

50,000

5.00

12/10/2018

-

Stock Grant

500,000

1,420,000

Kevin Hess

Option Grant

75,000

6.00

05/18/2018

-

-

Option Grant

15,000

5.00

12/10/2018

-

-

Felicia Hess

Option Grant

75,000

6.00

05/18/2018

-

-

Option Grant

5,000

5.00

12/10/2018

-

-

Stock Grant

0

0

431,500

1,225,460

Daniyel Erdberg

Option Grant

75,000

6.00

05/18/2018

-

-

Option Grant

10,000

5.00

12/10/2018

-

-

Stock Grant

0

0

332,500

944,300

(1)

These are unvested awards of restricted stock which
will vest, if at all, as follows: (i) in the case of Mr. Nussbaum, 450,000 shares of common awarded on September 26, 2016, that
vest subject to performance-based vesting which has not yet occurred, and 50,000 shares of common stock awarded on June 1, 2015
that vest on June 1, 2017; (ii) in the case of Ms. Hess, 431,500 shares of common awarded on September 26, 2016 that vest subject
to performance-based vesting which has not yet occurred; and (iii) in the case of Mr. Erdberg, 332,500 shares of common awarded
on September 26, 2016 that vest subject to performance-based vesting which has not yet occurred.

(2)

The market value shown was determined by multiplying
the number of shares of restricted stock that have not vested by the $2.84 closing bid price per share of our common stock on
December 31, 2016, the last trading day of our fiscal 2016.

30

Director
Compensation

The
following table sets forth director compensation for the fiscal year ended December 31, 2016 (excluding compensation to the Company’s
executive officers set forth in the summary compensation table above) paid by the Company.

Name

Fees Earned or Paid in Cash

Total ($)

Michael Haas

$

30,000

$

30,000

Maj. Gen. Wayne P. Jackson (Ret.)

$

24,000

$

24,000

Lt. Gen. Michael T. Flynn (Ret.) (1)

$

27,000

$

27,000

Total:

$

129,000

$

129,000

(1)

Lt.
Gen. Flynn was appointed as a director on April 27, 2016 and resigned effective December 31, 2016 to become President Trump’s
National Security Advisor. Lt. Gen. Flynn disclaimed all interest in vested and unvested restricted stock awards and
therefore did not effectively receive any stock-based compensation.

The
following table sets forth the number of shares of and percent of the Company's common stock beneficially owned as of March 17,
2017, by all directors, our named executive officers, our directors and executive officers as a group, and persons or groups
known by us to own beneficially 5% or more of our Common Stock or our Preferred Stock having voting rights.

The
percentages in the table have been calculated on the basis of treating as outstanding for a particular person, all shares of
our capital stock outstanding on March 17, 2017. On March 17, 2017, there were 8,682,220 shares of our common stock
outstanding. To calculate a stockholder's percentage of beneficial ownership, we include in the numerator and denominator the
common stock outstanding and all shares of our common stock issuable to that person in the event of the exercise of
outstanding options and other derivative securities owned by that person which are exercisable within 60 days of March 17,
2017. Common stock options and derivative securities held by other stockholders are disregarded in this calculation.
Therefore, the denominator used in calculating beneficial ownership among our stockholders may differ. Unless we have
indicated otherwise, each person named in the table has sole voting power and sole investment power for the shares listed
opposite such person's name.

31

(2)

Represents
1,450,834 shares of common stock and 500,000 shares of common stock on an as-converted basis in respect of a convertible note
payable by the Company to Dr. Frost.

(3)

Represents
1,593,433 shares of common stock, 500,000 shares of common stock on an as-converted basis in respect of a convertible note
payable by the Company to Mr. Nussbaum and 50,000 shares underlying vested options with an exercise price of $5.00 which expire
on December 10, 2018.

(4)

Represents
1,189,833 shares of common stock, 75,000 shares underlying vested options with an exercise price of $6.00 which expire in
May 2018 and 5,000 shares of shares underlying vested options with an exercise price of $5.00 which expire in
December 2018.

(5)

Represents
853,833 shares of common stock, 75,000 shares underlying vested options with an exercise price of $6.00 which expire in May
2018 and 10,000 shares underlying vested options with an exercise price of $5.00 which expire in December
2018.

(6)

Represents
50,000 shares of common stock, 75,000 shares underlying vested options with an exercise price of $6.00 which expire in May
2018 and 15,000 shares underlying vested options with an exercise price of $5.00 which expire in December 2018.

Equity
Compensation Plan Information

The
following table provides information as of December 31, 2016, regarding our compensation plans under which equity securities are
authorized for issuance:

Plan category

Number of securities to be issued upon exercise of outstanding options, warrants and rights

During
the last two fiscal years, there have been no transactions in which any director, executive officer or beneficial holder of more
than 5% of the outstanding common or preferred stock, or any of their respective relatives, spouses, associates or affiliates,
has had or will have any direct or material indirect interest. We have no policy regarding entering into transactions with affiliated
parties.

32

Director
Independence

We
are required to have two independent members of our Board of Directors and an Audit Committee with a majority of independent directors
under the OTCQX Rules for U.S. Companies. Our Board of Directors determined in its business judgment that Wayne Jackson and Michael
Haas are independent within the meaning of the OTCQX Rules for U.S. Companies, the Sarbanes-Oxley Act of 2002, and related SEC
rules.

Item
14. Principal Accounting Fees and Services.

The
Audit Committee pre-approves all auditing services and all permitted non-auditing services (including the fees and terms thereof)
to be performed by our independent registered public accounting firm.

Audit
Fees

Audit
fees consist of fees billed for services associated with the audit of our annual financial statements, review of the Company’s
financial statements included in Quarterly Reports on Form 10-Q, and services normally provided by the accounting firm for statutory
and regulatory filings or engagements. For the year ended December 31, 2016, the audit fees totaled approximately $50,500. For
the year ended December 31, 2015, the audit fees totaled approximately $45,000.

Audit-Related
Fees

We
did not incur any fees payable to our independent auditors for assurance and related services reasonably related to the performance
of the audit or review of our financial statements during the fiscal years ended December 31, 2016 and 2015.

Tax
Fees

We
did not incur any fees payable to our independent auditors for professional services for tax compliance, tax advice, and tax planning
during the fiscal years ended December 31, 2016 and 2015.

All
Other Fees

We
did not incur any fees payable to our independent auditors during the fiscal years ended December 31, 2016 and 2015 for products
or services provided by our independent registered public accounting firm.

33

PART
IV

Item
15. Exhibits and Financial Statement Schedules.

(a)
The following documents are filed as a part of this report or incorporated herein by reference:

(1)

Our
Consolidated Financial Statements and Notes thereto begin on page F-1 of this Annual Report immediately after the signature
page.

Index
to Financial Statements:

Report
of Independent Registered Public Accounting Firm

Consolidated
Balance Sheets for the Years Ended December 31, 2015 and 2016

Consolidated
Statements of Operations for the Years Ended December 31, 2015 and 2016

Consolidated
Statements of Stockholders’ Equity for the Years Ended December 31, 2015 and 2016

Consolidated
Statements of Cash Flows for the Years Ended December 31, 2015 and 2016

Notes
to Consolidated Financial Statements

(2)

Financial
Statement Schedules: All schedules have been omitted because the required information is included in the Consolidated Financial
Statements or the Notes thereto, or because it is not required.

(3)

Exhibits:
The information required by Section (a)(3) of Item 15 of Form 10-K is set forth on the Exhibit Index that immediately precedes
the exhibits filed with this Annual Report.

34

SIGNATURES

Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.

DRONE
AVIATION HOLDING CORP.

Date: March
17, 2017

By:

/s/
JAY H. NUSSBAUM

Jay
H. Nussbaum

Chief
Executive Officer

Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons in the
capacities and on the dates indicated.

Certification of the Chief Executive Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

–

–

–

–

X

31.2

Certification of the Chief Financial Officer pursuant to Exchange Act Rules 13a-14(a) and 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

–

–

–

–

X

32**

Certifications of the Chief Executive Officer and the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

–

–

–

–

X

101 INS***

XBRL Instance Document

–

–

–

–

X

101 SCH***

XBRL Taxonomy Extension Schema Document

–

–

–

–

X

101 CAL***

XBRL Taxonomy Calculation Linkbase Document

–

–

–

–

X

101 LAB***

XBRL Taxonomy Labels Linkbase Document

–

–

–

–

X

101 PRE***

XBRL Taxonomy Presentation Linkbase Document

–

–

–

–

X

101 DEF***

XBRL Taxonomy Extension Definition Linkbase Document

–

–

–

–

X

*

Indicates management contract or compensatory plan or
arrangement.

**

Furnished herewith

***

These documents formatted in XBRL (Extensible Business
Reporting Language) have been attached as Exhibit 101 to this report

39

DRONE
AVIATION HOLDING CORP.

Financial
Statements Together With

Report
of Independent Registered Public Accounting Firm

For
the Years Ended December 31, 2016 and 2015

REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To
the Board of Directors

Drone
Aviation Holding Corp.

Jacksonville,
FL

We
have audited the accompanying consolidated balance sheets of Drone Aviation Holding Corp. and its subsidiaries (collectively the
“Company”) as of December 31, 2016 and 2015, and the related consolidated statements of operations, stockholders’
equity and cash flows for the years then ended. These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based on our audits.

We
conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those
standards require that we plan and perform an audit to obtain reasonable assurance about whether the financial statements are
free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control
over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing
audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness
of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit includes examining,
on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing
the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.

In
our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position
of Drone Aviation Holding Corp. and its subsidiaries as of December 31, 2016 and 2015 and the results of their operations and
their cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States
of America.

/s/
MaloneBailey, LLP

www.malonebailey.com

Houston,
Texas

March
17, 2017

F-1

DRONE
AVIATION HOLDING CORP.

CONSOLIDATED
BALANCE SHEETS

12/31/2016

12/31/2015

ASSETS

CURRENT ASSETS:

Cash

$

2,015,214

$

2,659,734

Accounts receivable - trade

394,000

83,288

Inventory, net

459,885

118,795

Prepaid expenses and deposits

120,614

55,624

Total current assets

2,989,713

2,917,441

PROPERTY AND EQUIPMENT, at
cost:

179,627

163,291

Less - accumulated depreciation

(60,784

)

(26,995

)

Net property and equipment

118,843

136,296

OTHER ASSETS:

Goodwill

99,799

99,799

Intangible assets, net

1,289,667

1,460,000

Total other assets

1,389,466

1,559,799

TOTAL ASSETS

$

4,498,022

$

4,613,536

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:

Accounts payable - trade and accrued liabilities

$

293,922

$

242,257

Accounts payable due to related party

46,849

6,000

Deferred revenue

-

7,896

Related party convertible notes payable - Series 2016, net of discount of $2,092,156

The
accompanying notes are an integral part of these consolidated financial statements.

F-6

Drone
Aviation Holding Corp.

Notes
to Consolidated Financial Statements

For
the Years ended December 31, 2016 and 2015

1.

SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES

Description
of Business:

Drone
Aviation Holding Corp. (“Drone” or “Company”) develops and manufactures cost-effective, compact and rapidly
deployable aerial platforms including lighter-than-air aerostats and electric-powered drones designed to provide government and
commercial customers with enhanced surveillance and communication capabilities. Utilizing a proprietary tether system, the Company's
products are designed to provide prolonged operational duration capabilities combined with improved reliability, uniquely fulfilling
critical requirements in military, law enforcement and commercial and industrial applications.

Basis
of Presentation:

The
accompanying financial statements of the Company were prepared in accordance with accounting principles generally accepted in
the United States of America (“U.S. GAAP”).

Principle
of Consolidation:

Our
consolidated financial statements as of December 31, 2016 and 2015 include the accounts of Drone Aviation Holding Corp. and its
subsidiaries: Drone AFS Corp. and Lighter Than Air Systems Corp (“LTAS”).

Use
of Estimates:

The
preparation of financial statements in conformity with accounting principles generally accepted in the United States of America
requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities, and the reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.

Concentration
of Credit Risk:

Financial
instruments which potentially subject the Company to concentrations of credit risk consist of cash and trade receivables. The
Company places its cash with high credit quality financial institutions. At times such cash may be in excess of the FDIC limit
of $250,000 per depositor. With respect to trade receivables, the Company routinely assesses the financial strength of its customers
and, as a consequence, believes that the receivable credit risk exposure is limited.

Cash
Equivalents:

Cash
equivalents are represented by operating accounts or money market accounts maintained with insured financial institutions, including
all highly-liquid investments with maturities of three months or less when purchased to be cash equivalents. The Company had no
cash equivalents as of December 31, 2016 and 2015.

Accounts
Receivable and Credit Policies:

Accounts receivable-trade consists of
amounts due from the sale of tethered aerostats, accessories, spare parts customization and refurbishment of aerostats. Such
accounts receivable are uncollateralized customer obligations due under normal trade terms requiring payment within 30 days of
receipt of the invoice. The Company provides an allowance for doubtful accounts equal to the estimated uncollectible
amounts based on historical collection experience and a review of the current status of trade accounts receivable. At
December 31, 2016 and 2015, the Company characterized $0 and $0 as uncollectible, respectively. There is a balance of $394,000
in accounts receivable-trade at December 31, 2016 for sales on account.

F-7

Inventories

Inventories
are stated at the lower of cost or market, using the first-in first-out method. Cost includes materials, labor and manufacturing
overhead related to the purchase and production of inventories. We regularly review inventory quantities on hand, future purchase
commitments with our supplies, and the estimated utility of our inventory. If the review indicates a reduction in utility below
carrying value, we reduce our inventory to a new cost basis through a charge to cost of goods sold.

Property
and Equipment:

Property
and equipment is recorded at cost when acquired. Depreciation is provided principally on the straight-line method over
the estimated useful lives of the related assets, which is 3-7 years for equipment, furniture and fixtures, hardware and software. Property
and equipment consists of the following at December 31, 2016 and 2015:

2016

2015

Shop Machinery and equipment

$

87,029

$

80,889

Computers and electronics

35,270

28,911

Office furniture and fixtures

37,814

33,977

Leasehold improvements

19,514

19,514

179,627

163,291

Less - accumulated depreciation

(60,784

)

(26,995

)

$

118,843

$

136,296

Expenditures
for maintenance and repairs are charged to expense as incurred, whereas expenditures for major renewals and betterments that extend
the useful lives of property and equipment are capitalized.

During
the year ended December 31, 2016 and 2015, the Company purchased $16,336 and $129,227 of furniture and equipment, respectively.

The
Company recognized $33,789 and $19,955 of depreciation expense for the year ended December 31, 2016 and 2015, respectively.

Long-Lived
Assets & Goodwill:

The
Company accounts for long-lived assets in accordance with the provisions of Financial Accounting Standards Board (“FASB”)
Accounting Standards Codification (“ASC”) 360-10-35, “Impairment or Disposal of Long-lived Assets.” This
accounting standard requires that long-lived assets be reviewed for impairment whenever events or changes in circumstances indicate
that the carrying amount may not be recoverable. Recoverability of assets to be held and used is measured by a comparison
of the carrying amount of an asset to future undiscounted net cash flows expected to be generated by the asset. If
the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which
the carrying amount of the asset exceeds the fair value of the asset. In conjunction with the Company’s acquisition
of LTAS in 2014, the Company acquired the LTAS customer list. The fair value of the customer list was determined by using a discounted
cash flow model and $135,550 was recorded on the date of business combination. We recorded $31,941 of amortization expense for
the year ended December 31, 2014, leaving a remaining carrying value of $103,609. The Company recorded another $37,935 amortization
expense for the year ended December 31, 2015. After comparing the acquired customer list to the actual customers who placed orders
following the acquisition of LTAS, the Company determined that the customer list was impaired at December 31, 2015 and amortized
the remaining balance of $65,674 in 2015.

The
Company accounts for goodwill and intangible assets in accordance with ASC 350 "Intangibles Goodwill and Other". ASC
350 requires that goodwill and other intangibles with indefinite lives be tested for impairment annually or on an interim basis
if events or circumstances indicate that the fair value of an asset has decreased below its carrying value. The Company performed
impairment analysis using the qualitative analysis under ASC 350-20 and, except as discussed above regarding the LTAS customer
list at December 31, 2015, noted no impairment issues for 2016 and 2015.

F-8

Derivative
Financial Instruments:

The
Company evaluates the embedded conversion feature within its convertible debt instruments under ASC 815-15 and ASC 815-40 to determine
if the conversion feature meets the definition of a liability and, if so, whether to bifurcate the conversion feature and account
for it as a separate derivative liability. For derivative financial instruments that are accounted for as liabilities, the derivative
instrument is initially recorded at its fair value and is then re-valued at each reporting date, with changes in the fair value
reported in the statements of operations. For stock-based derivative financial instruments, the Company uses a lattice model,
in accordance with ASC 815-15 “Derivative and Hedging” to value the derivative instruments at inception and on subsequent
valuation dates. The classification of derivative instruments, including whether such instruments should be recorded as liabilities
or as equity, is evaluated at the end of each reporting period. Derivative instrument liabilities are classified in the balance
sheet as current or non-current based on whether net-cash settlement of the derivative instrument could be required within 12
months after the balance sheet date.

Beneficial
Conversion Features:

The
Company evaluates the conversion feature for whether it was beneficial as described in ASC 470-30. The intrinsic value of a beneficial
conversion feature inherent to a convertible note payable, which is not bifurcated and accounted for separately from the convertible
note payable and may not be settled in cash upon conversion, is treated as a discount to the convertible note payable. This discount
is amortized over the period from the date of issuance to the date the note is due using the effective interest method. If the
note payable is retired prior to the end of its contractual term, the unamortized discount is expensed in the period of retirement
to interest expense. In general, the beneficial conversion feature is measured by comparing the effective conversion price, after
considering the relative fair value of detachable instruments included in the financing transaction, if any, to the fair value
of the shares of common stock at the commitment date to be received upon conversion.

Fair
Value of Financial Instruments:

The
Company measures its financial assets and liabilities in accordance with the requirements of FASB ASC 820, “Fair Value Measurements
and Disclosures”. As defined in FASB ASC 820, the fair value is the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The Company
utilized the market data of similar entities in its industry or assumptions that market participants would use in pricing the
asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs
can be readily observable, market corroborated, or generally unobservable. The Company classifies fair value balances based on
the observability of those inputs. FASB ASC 820 established a fair value hierarchy that prioritizes the inputs used to measure
fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities
(level 1 measurement) and the lowest priority to unobservable inputs (level 3 measurement) as follows:

Level
1 – Quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active
markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide
pricing information on an ongoing basis. Level 1 primarily consists of financial instruments such as exchange-traded
derivatives, marketable securities and listed equities.

Level
2 – Pricing inputs are other than quoted prices in active markets included in level 1, which are either directly or indirectly
observable as of the reported date and includes those financial instruments that are valued using models or other valuation methodologies.
These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities,
time value, volatility factors, and current market and contractual prices for the underlying instruments, as well as other relevant
economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument,
can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.
Instruments in this category generally include non-exchange-traded derivatives such as commodity swaps, interest rate swaps, options
and collars.

F-9

Level
3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may
be used with internally developed methodologies that result in management’s best estimate of fair value.

Revenue
Recognition and Unearned Revenue:

The
Company recognizes revenue when all four of the following criteria are met: 1) persuasive evidence of an arrangement exists; 2)
delivery has occurred and title has transferred or services have been rendered; 3) our price to the buyer is fixed or determinable;
and 4) collectability is reasonably assured. We record unearned revenue as a liability and the associated costs of sales as work
in process inventory. In 2015, the Company deferred recognizing $7,896 in revenue from a 2015 sale that was delivered in January
2016.

Income
Taxes:

The
Company accounts for income taxes utilizing ASC 740, “Income Taxes” (SFAS No. 109). ASC 740 requires the
measurement of deferred tax assets for deductible temporary differences and operating loss carry forwards, and of deferred tax
liabilities for taxable temporary differences. Measurement of current and deferred tax liabilities and assets is based
on provisions of enacted tax law. The effects of future changes in tax laws or rates are not included in the measurement. The
Company recognizes the amount of taxes payable or refundable for the current year and recognizes deferred tax liabilities and
assets for the expected future tax consequences of events and transactions that have been recognized in the Company’s financial
statements or tax returns. The Company has recorded a 100% valuation allowance against net deferred tax assets due
to uncertainty of their ultimate realization. Valuation allowances are established when necessary to reduce deferred
tax assets to the amount expected to be realized.

The
Company also follows the guidance for accounting for income tax uncertainties. In accounting for uncertainty in income taxes,
the Company recognizes the financial statement benefit of a tax position only after determining that the relevant tax authority
would more likely than not sustain the position following an audit. For tax positions meeting the more likely than not threshold,
the amount recognized in the consolidated financial statements is the largest benefit that has a greater than 50% likelihood of
being realized upon ultimate settlement with the relevant tax authority. No liability for unrecognized tax benefits was recorded
as of December 31, 2016 and 2015.

Employee
Stock-Based Compensation:

The
Company accounts for stock-based compensation in accordance with ASC 718, “Compensation-Stock Compensation”. ASC 718
requires companies to measure the cost of employee services received in exchange for an award of equity instruments, including
stock options, based on the grant-date fair value of the award and to recognize it as compensation expense over the period the
employee is required to provide service in exchange for the award, usually the vesting period. The Company has elected to early
adopt ASU 2016-09 and has a policy to account for forfeitures as they occur.

Non-Employee
Stock-Based Compensation:

The
Company accounts for stock-based compensation in accordance with the provision of ASC 505-50, “Equity Based Payments to
Non-Employees,” which requires that such equity instruments are recorded at their fair value on the measurement date. The
measurement of stock-based compensation is subject to periodic adjustment as the underlying equity instruments vest.

Related
Parties:

The
Company accounts for related party transactions in accordance with ASC 850 (“Related Party Disclosures”). A party
is considered to be related to the Company if the party directly or indirectly or through one or more intermediaries, controls,
is controlled by, or is under common control with the Company. Related parties also include principal owners of the Company, its
management, members of the immediate families of principal owners of the Company and its management and other parties with which
the Company may deal if one party controls or can significantly influence the management or operating policies of the other to
an extent that one of the transacting parties might be prevented from fully pursuing its own separate interests. A party which
can significantly influence the management or operating policies of the transacting parties or if it has an ownership interest
in one of the transacting parties and can significantly influence the other to an extent that one or more of the transacting parties
might be prevented from fully pursuing its own separate interests is also a related party.

F-10

The
accounts payable due to related parties at December 31, 2015 was comprised of $6,000 in director fees which were paid in January
2016.

Aerial
Products Corp (“APC”) was a related party controlled by Kevin Hess, the Chief Technology Officer of our Company. Total
charges from APC to LTAS during the years ended December 31, 2016 and 2015 were $0 and $7,549 respectively. The Company purchased
used fixed assets from APC at fair market value for $6,500 during the year ended December 31, 2015.

As
of December 31, 2016, there was $46,840 accrued interest payable to related parties on convertible notes payable. See Note 5 –
Related Party Convertible Notes Payable and Derivative Liability for further information.

Earnings
or Loss per Share:

The
Company accounts for earnings per share pursuant to ASC 260, Earnings per Share, which requires disclosure on the financial statements
of "basic" and "diluted" earnings (loss) per share. Basic earnings (loss) per share are computed by dividing
net income (loss) by the weighted average number of common shares outstanding for the year. Diluted earnings (loss) per share
is computed by dividing net income (loss) by the weighted average number of common shares outstanding plus common stock equivalents
(if dilutive) related to stock options and warrants for each year. As there was a net loss for the years ended December 31, 2016
and 2015, basic and diluted losses per share in each such year are the same.

Recent
Accounting Pronouncements

The
Company has early-adopted ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting” which amends ASC
718 – account for forfeitures as they occur. Policy election only relates to the service condition aspects of awards; the
likelihood of achieving performance conditions will still need to be assessed each period. There was no impact from the adoption
of this ASU on the Company’s financial statements.

The
Company is currently evaluating ASU 2014-09, “Revenue from Contracts with Customers (Topic 606)” and ASC 842 “Leases”
for future adoption. Other than those pronouncements, management does not believe that there are any other recently issued, but
not effective, accounting standards which, if currently adopted, would have a material effect on the Company's financial statements.

2.

INVENTORIES

Inventories
consisted of the following:

2016

2015

Raw Materials

$

48,014

$

26,358

Work in progress

254,258

3,817

Finished Goods

160,819

107,209

Less valuation allowance

(3,206

)

(18,589

)

Total

$

459,885

$

118,795

3.

PREPAID
EXPENSES

Prepaid
expenses consisted of the following:

2016

2015

Prepaid insurance

$

29,911

$

25,517

Prepaid products and services

83,515

24,192

Prepaid rent and security deposit

7,188

5,915

$

120,614

$

55,624

F-11

4.

INTANGIBLE
ASSETS

On
July 20, 2015, the Company, through its wholly-owned subsidiary Drone AFS Corp., purchased substantially all the assets of Adaptive
Flight, Inc. (“AFI”), a Georgia corporation. The Company purchased assets, including, but not limited to, intellectual
property, licenses and permits, including commercial software licenses for the “GUST” (Georgia Tech UAV Simulation
Tool) autopilot system and other transferable licenses which include flight simulation and fault tolerant flight control algorithms.
The Company paid $100,000 in immediately available funds and $100,000 to be held in escrow. In addition, the Company issued 150,000
shares of unregistered common stock valued at $8.40 per share, on a post-October 29, 2015 reverse stock split basis, on the date
of agreement, to be held in escrow.

The
Company had a milestone of twelve months to complete a technology integration plan, the non-completion of which could result in
the return of the purchased assets and termination of the Company’s obligations to release the escrow cash and shares. Additional
milestones included exclusive, no-cost and perpetual licenses to all contributing intellectual property included or related to
the purchased assets. As such time as all milestones were met, one-half of the escrow shares were to be released to AFI. Upon
termination of the escrow agreement, anticipated to be twelve months from the closing of the asset purchase, if all milestones
had been met, the remaining escrow shares would be released to AFI; but if all milestones have not been met, the escrow cash and
escrow shares would be released to the Company and the purchased assets would be returned to AFI. According to the terms of the
Escrow Agreement, if the escrow share value was less than $1,400,000, the Company must issue an additional number of unregistered
shares, not to exceed 50,000 shares. At December 31, 2015, the value of the 150,000 shares was $3.23 per share, or $484,500. The
Company recorded $161,500 as an additional liability and expense at December 31, 2015 for the cost of 50,000 shares at $3.23 per
share. On June 3, 2016, the Integration Plan was deemed to be completed. At June 3, 2016, the value of the 150,000 shares was
$3.01 per share, or $451,150. The additional liability was reduced to $150,500 for the cost of 50,000 shares at $3.01 per share.
The Company recorded the $11,000 reduction in the additional liability through the statement of operations at June 3, 2016. The
Company began amortizing the $1,460,000 of purchased assets over a sixty month period on June 3, 2016 in the amount of $24,333
per month. Total amortization expense for the year ended December 31, 2016 was $170,333. The remaining unamortized balance of
$1,289,667 is estimated be amortized in the estimated amounts of $292,000 per year for 2017 through 2020 and $121,667 in 2021.

The
asset acquisition did not qualify as a business combination under ASC 805-10 and has been accounted for as a regular asset purchase.

5.

RELATED
PARTY CONVERTIBLE NOTES PAYABLE AND DERIVATIVE LIABILITY

On
September 29, 2016, the Company issued Convertible Promissory Notes Series 2016 due October 1, 2017 in the aggregate principal
amount of $3,000,000 in a private placement to the Chairman of the Board and the Chairman of the Strategic Advisory Board of the
Company, both of whom are greater than 10% shareholders of the Company. The notes bear interest at a rate of six percent (6%)
per annum. The Company may prepay the notes at any time without penalty. If the Company does not prepay a note in full or the
holder does not convert the note before the maturity date, the Company may pay the outstanding principal amount and any accrued
and unpaid interest on the maturity date with cash or with common stock or through a combination of cash and stock at the Company’s
discretion. The conversion price of the notes is the lesser of $3.00 per share or eight-five percent (85%) of the lowest per share
purchase price of common stock in the next sale of common stock in which the Company receives gross proceeds of an amount greater
than or equal to $3,000,000.

Under
ASC 815, these notes require liability classification and must be measured at fair value at the end of each reporting period.

F-12

The
following table sets forth, by level within the fair value hierarchy, the Company’s financial liabilities that were accounted
for at fair value as of December 31, 2016 and December 31, 2015:

Level 1

Level 2

Level 3

Total

LIABILITIES:

Derivative liabilities as of December 31, 2016

$

0

$

0

$

1,832,013

$

1,832,013

Derivative liabilities as of December 31, 2015

$

0

$

0

$

0

$

0

The
following table represents the change in the fair value of the derivative liabilities during the year ended December 31, 2016:

Fair value of derivative liabilities as of December 31, 2015

$

0

Fair value of derivative liability at December 31, 2016 recorded as debt discount

2,394,974

Change in fair value of derivative liabilities

(562,961

)

Fair value of derivative liabilities as of December 31, 2016

$

1,832,013

The
amortization of the debt discount is $302,818 for the year ended December 31, 2016. The $3,000,000 payable associated with the
Convertible Promissory Notes Series 2016 due October 1, 2017 is $907,844 as of December 31, 2016, net of a $2,092,156 debt discount
which is being amortized over the life of the loan using the effective interest method.